Copper in a Deflationary Environment:
An Alternative View
By Lawrence Williams
Since the beginning of the year,base metals (copper in particular), have staged a fightback from the depths reached in October/ November of 2008. As a result, base metals mining stocks - or at least those with prospects and with operations in what might be considered politically safe environments - have made huge returns for their investors in a few short months. Recently stock markets have been picking up, leading to a sense of euphoria in the investment community. The recession is over and stocks will again be seeing a heady climb - perhaps even to new heights! Or will they? Much of what follows here will discount this theory and is based on a presentation by Simon Hunt of copper analysts Simon Hunt Strategic Services at the last Metal Bulletin International Copper Conference in Bilbao. Before proceeding further, perhaps one should add that amongst copper analysts Hunt is seen as a bit of a maverick. However, often mavericks are proved right in time. For example Hunt predicted at the same conference three years earlier a forthcoming global credit crisis, a recession and copper prices trading within a range of $2,500 to $10,000. This was a very prescient forecast in the light of what has happened since. This year, following a succession of speakers who were decidedly bullish about the path forward for base metals prices, Hunt was again the party pooper,pointing to the consequences of extreme levels of debt, deleveraging, high levels of interest rates in the U.S. and elsewhere, falling inflation, high real mortgage rates, the collapse in household debt growth to levels not seen since the great depression and matched by soaring government debt, collapsing velocity of money and a rapidly falling trade deficit. He also explained what, in his view, may be the effects of this combination of factors on metals prices over the next few years. “In short,” says Hunt, “we have entered an entirely different world. Forget what we have experienced in recent years; those rates of growth and those conditions will not be seen for a decade or so. And forget about inflation. We are in the early stages of debt deflation which will impact metal prices of all descriptions.”
Hunt expressed the observation that there is now the convergence of a credit crisis coinciding with the end of a number of business cycles (Kondratieff Wave) ending around the end of the decade and this creates a troublesome outlook. “The fundamental problem,” says Hunt, “is that debt in many countries, especially in the USA, has reached such dimensions that a long period of deleveraging is inevitable. Now, in the USA, total private sector debt is collapsing, and is matched by soaring government debt.” He goes on to point out that the similarities between the present time and the 1930-1932 period are worrying. In the great depression years, although the Dow plunged by a massive 86%, the decline was interrupted by massive rallies. Indeed a week earlier, Niall Ferguson, the British historian who specializes in financial and economic history and is the Laurence A. Tisch Professor of History at Harvard University and the William Ziegler Professor of Business Administration at Harvard Business School, said at a conference in Hamburg that we are at April 1931. We have not yet arrived at the Great Depression. That is coming!
Back to the Kondratieff Wave The Kondratieff Wave Theory is named after Russian economist Nicolai Kondratieff who promulgated it in a book published in 1925 entitled The Major Economic Cycles. Averaging fifty and ranging from approximately forty to sixty years in length, the cycles consist of alternating periods of high sectoral growth and periods of slower growth. Unlike the short-term business cycle, which in various forms has been familiar since the nineteenth century, the long wave of this theory does not belong within current orthodox economics and is sometimes categorized as part of heterodox economics (a catch-all term for alternative ideas). Hunt suggests that we are in the
winter cycle of the Kondratieff long-term wave, which should last until around 2017. This would mean that the business trend is downwards, interspersed with recoveries which will tend to last months rather than years. If this is indeed the case then the recent market rallies should be viewed with suspicion in the long term scheme of things.
In part as a consequence of the down cycle, Hunt views the trend in global consumption of metals in general, and copper in particular, as very weak. The SHSS predicted rage range is from plus 0.5% a year to minus 1.8% a year
to 2018. He believes that the surge in copper prices towards the end of the up cycle has led end users to understand
fully what drove prices up in the last four years and are designing copper out of their systems as much as they can, or
minimising its use via tighter specifications. In the longer term, we should watch out for developments in superconductivity and nanotubes. Hunt casts doubts on the officially stated GDP and growth figures. He has visited China regularly since 1993 and believes that no-one really knows what China’s actual copper consumption is. “The problem is that so much of wire rod and brass mill output is derived from small mills which people tend to disregard.
In 2007, for instance, the small Chinese upward cast rod mills accounted for over 40% of total wire rod production.
Probably 25% have had to shut down since mid-2008,” Hunt says. SHSS believes that around 170kt of SRB-purchased cathode actually entered the country in the first four months of this year, not 70kt, as reported. Thus the surplus, mostly held outside the reporting system, was around 500kt at the end of April. The estimate now is that by
the end of this month it will be around 800kt, held by hedge funds, merchants, Chinese financial institutions, individuals, fabricators and private sector companies having nothing to do with the industry. These purchases are a bet on rising prices. Most, if not all, of this material is held outside the reporting system. Thus fundamentals suggest that lower prices will be seen in an increasingly volatile marketplace for the metal, but with the global economy facing a renewed downturn, prices may dive from 2011 onwards. Overall, Hunt feels that over the next two years or so prices should trade in a range of $3,000 to $6,000 and then collapse as the world economy is hit by the killer wave or its next big leg down. He ended with a warning: “Remember, history repeats itself because nobody remembers it!” (www.mining.com)
