15:39 March 15, 2010
To see copper price rising back to its 2007 bubble level (see below chart) baffles me to the point of suspecting that I somehow teleported into an alternative world where my education (in engineering), industry experience and common sense have all but somehow expired or made obsolete. (Maybe they truly are. But here is my simple argument – you decide if you can beat this.)
Copper cash buyer price (USD/ tonne, LME)
First thing first: copper is fundamentally different to gold. Gold’s “irrationality” is perfectly normal and can be justified (see IIFL’s The Gold Report) because gold is useless in practical utilities and inherently “irrational”. But copper is a base metal and as such follows the economics of physical supply and demand.
A lot of copper talks surround the colourful but already beaten-to-death argument about China’s “insatiable appetite”. I’m not going to argue against that for now because “Chinese demand” is the same as any demand and follows the same logics for economic choices. The problem here is demand, long-term physical demand to be precise.
My argument is a simple one: Copper can be substituted in roughly two-third of its applications. To quote the US Geology Survey: “Aluminum substitutes for copper in power cables, electrical equipment, automobile radiators, and cooling and refrigeration tube; titanium and steel are used in heat exchangers; optical fiber substitutes for copper in some telecommunications applications; and plastics substitute for copper in water pipe, drain pipe, and plumbing fixtures.” Yet for some unknown reason it seems nobody in the market care to mention this basic fact about the metal.
Substitution can happen and it does happen if copper price is too high; it just takes time for the demand to be destructed. Power transmission is the most sticking copper usage, yet in 2006 China had already reported that copper started to show signs of losing market share to aluminium, especially in low-voltage power transmission. Simon Hunt Strategic Services forecasted that China will lose 500,000 tonnes of copper consumption to substitutes. To put it into context, China’s 2009 copper consumption is estimated at 5.4 million tonnes (source: Antaike). The wildly successful Chinese stimulus contributed to 10.2% demand growth in 2009. True consumption figure is difficult to ascertain due to the Chinese strategic reserves purchase and corporate stockpiling at 1H 2009 prices. The effects of both factors are likely to wane in the coming years.
Here I can even offer a personal account on copper’s substitution. I was back in Beijing for the Chinese New Year in February. One day I found that the copper duct of my bath tub was broken (yes, copper does erode; it looks like gold but it is not gold). I went out to B&Q to buy a new set of copper duct for RMB400 and called a contractor to install it for RMB100. The contractor came and laughed at me when he saw the copper duct. He told me to return it and to buy a plastic one, which is easier to install and may last longer (my previous copper one lasted only 4 years). I did what he told me to do and get my bath tub perfectly fixed – for RMB200 in total, labour included.
Now let’s switch to the inflation and US dollar argument, which has some basis but largely have been mistaking base metal for precious metal. Nevertheless, let’s look at other base metals at the below charts:
Aluminium cash price (USD/tonne, LME)
Lead cash price (USD/tonne, LME)
Zinc cash price (USD/tonne, LME)
The conclusion should be easy to see: even if you want to hold base metals ( ! ) to fend off inflation, aluminium, lead and zinc are much better choices than the over-priced copper at the moment. Remember that (I actually hate to state the obvious) lead and zinc have virtually no substitutes because they are already cheap – beat that!