Buildout of “Industry 4.0” Bodes Well for Copper Price Outlook 2017
Good times could be in store for copper miners in 2017. The latest copper price forecast looks bullish, due to favorable factors shaping up for the industry.
Let’s start with the anticipated buildout of “Industry 4.0,” or the great modernization, as I like to think of it. With the cycle of globalization reversing and companies looking to re-onshore production to the Unites States in new modern manufacturing hubs, this should drive copper price trends higher.
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Older factories will also be forced to modernize their facilities to compete with new, more efficient factories. This means lots of robotic and automated machinery will be installed, and this equipment is particularly cable-intensive.
That’s an especially bullish prospect, because the Copper Development Association (CDA) estimates that electrical applications account for 65% of copper usage, with construction accounting for an additional 25%. Although copper competes with other alloys like nickel and silver, none of them combine copper’s anti-corrosive and conductivity properties at such a low cost. Virtually all electrical wiring is still made from copper.
The following chart outlines the percentage of global copper production consumed by each industrial sector in the United States.
| Sector | % |
| Electrical | 65 |
| Construction | 25 |
| Transport | 7 |
| Other | 3 |
(Source: “Annual Data 2006: Copper Supply & Consumption — 1995–2015,” Copper Development Association, last accessed February 9, 2017.)
Adding to the bullish sentiment is the fact that world mine production will remain flat in 2017, after a four-percent increase in 2016. Analyst Chris LaFemina expects the global copper market to shift from a marginal oversupply in 2016 to flat in 2017, and to a slight deficit the following year. The copper market had been in surplus for seven of the past 10 years. (Source: “Trump’s Victory Isn’t Only Thing Behind Copper Rally,” The Wall Street Journal, November 14, 2016.)
High copper inventories have put downward pressure on prices for years, so a changing production dynamic is welcome news for the industry. At least for the time being, it doesn’t appear that much new supply will hit the market.
In 2016, about 25 new copper projects globally have been delayed by as long as two years, and a further 30 projects have been set back by as much as six years, according to state-owned miner Corporación Nacional del Cobre de Chile, or Codelco. Typically, a fresh mine output takes at least five years to bring to market. (Source: Ibid.)
Already anticipating the slowdown to come, industry leaders are starting to react. Mining conglomerate Rio Tinto plc (ADR) (NYSE:RIO) predicts that copper supply could fall well short of demand by 2020, while Freeport-McMoRan Inc (NYSE:FCX) predicts that the same may happen as soon as this year. Freeport-McMoran should know: it is the largest publicly traded copper producer in the world.
Will U.S. Copper Demand Compensate for Perceived Chinese Weakness?
Despite the favorable supply side dynamics and anticipated growth in manufacturing capital expenditure (CAPEX) in America, will Chinese demand follow through? The copper price outlook depends on it.
Consider that, in 2015, the U.S. accounted for about eight percent of global copper demand, while China accounted for 50%. We can see why. So, in a best-case scenario in which U.S. copper demand increases 20%, a mere three percent contraction in China’s demand for copper could offset net aggregate demand. Chinese demand clearly drives the market, and has so for years.
Despite the perception of slowing Chinese demand, built upon decades of overbuilding and a weak global economy, the reality is much different. While some investors believe that Chinese debt financing must be brought under control, thus weakening construction CAPEX, I believe that China is unlikely to do so in the near term. Or, at least it won’t unless debt gets large enough to pose a systematic risk to the economy. In other words, the can-kicking will continue.
Other prominent analysts are in agreement of near-term robust Chinese demand.
Andrew Cole of Metal Bulletin Research thinks that copper itself looks to be “one of the top performers … weighed down by perceptions of a weak China and rising supply.” However, he adds, “Since both of those views have swung around completely, there may still be some catching up to do in terms of investors who had been underweight copper moving to reposition to a more bullish stance, by increasing allocations and building long positions.” (Source: “Copper to Be Best Performing Commodity of 2017 – Analysts,” Mining.com, January 15, 2017.)
Goldman Sachs Group Inc (NYSE:GS) is jumping on the bandwagon as well. The usually bearish firm recently offered up a copper price prediction of $6,200 per tonne over the next six months, lifting its copper price forecast along the curve. “Although it is tempting to blame this on speculative positioning, the materially stronger fundamental developments that contributed to this surge in speculative interest are likely to underpin a more bullish environment for copper,” wrote Goldman Sachs in early December 2016. (Source: Ibid.)
Molly Shutt of BMI Research expects global copper deficits to emerge by 2019, echoing sentiments of the big producers. Coupled with increasing Chinese demand, she recently revised her copper price prediction upwards five percent, to about $2.30/lb. That’s a rather conservative take, considering where prices are trading but, nonetheless, she confirms that tighter supply versus demand dynamics are underway.
Copper prices themselves are the best reflection that market demand remains robust. Prices have risen from $2.38/lb on November 8, 2016 (U.S. presidential election) to $2.65/lb as of February 7, 2017. Of course, speculators have chased prices up on speculation that President Donald Trump’s policies will boost U.S. growth. But none of this would matter if Chinese growth remained slack.
I suspect that the most logical conclusion for the price increases lies somewhere in the middle.
Copper Price Forecast
Assuming a steady flow of demand from China, the intensity of copper price increases could largely depend on the intensity of industrial manufacturing construction, and all the associated copper intensive materials that go into them. Therefore, the viability of this trend depends on Trump’s ability to attract foreign manufacturing back to America.
Whether Fortune 500 manufacturers are coerced into onshoring or not is immaterial. If the factories go up, everybody will be forced to compete. As described earlier, not only will new factories be of the copper-intensive kind, but remaining international factories will be forced to invest in new automation to compete on price. This should be good for a percent or two of added copper demand globally, if Trump is successful.
It may not seem like much, but in tight (and getting tighter) supply conditions, it is significant.
So whichever factors investors incorporate into their copper price forecasts, don’t count on weak Chinese demand in 2017. China will keep spigots of credit growth open until a crisis causes a shock to the system. Until then, expect the Chinese construction boom to continue unabated.
In light of all the catalysts working in copper’s favor, I think prices will witness $3.20/lb this year (over 20% higher from current levels) and perhaps $4.00/lb copper sometime in 2018.
Much, of course, will depend on the direction of protectionist trade between the U.S. and its trading partners. But, assuming that world trade doesn’t fall off a cliff, and assuming that other factors mentioned in this article come together, copper can be the big winner among industrial metals.
One final word of caution: copper has shot up 12.6% since early November 2016, so caution is advised at these levels. Pullbacks are your friend. With proper position management, copper could indeed make a splendid adjunct holding to your investment portfolio.
