Portfolio Adviser - Portfolio Adviser February 2019 v2
Counterpoint
Ed Smith 2019-03-13 01:05:14
Doctor copper will CU now
Want to measure the pulse of the global economy? Ask ‘Dr Copper’, or so the adage goes.
Copper is all around us. You need it to build a house, a car or a hairdryer. The red metal is even one of the most intensively used raw materials in the green energy revolution: more electrical motors, more battery packs but fewer internal combustion engines means more copper wiring.
As a result, demand for copper ebbs and flows with the ups and downs of the business cycle.
Time lag
An expanding economy means using more copper. In fact, as a core component of many products, it is often ordered by manufacturers well before the final product comes out of the assembly line. That’s why a decrease in the demand for copper can provide an early indication of weakness in global activity.
Data confirming economic activity is generally only available with a considerable time lag. It can take at least six weeks for the first, error-prone estimate of quarterly GDP.
Copper is bought and sold with such frequency that its price changes by the second. This instantaneous pricing in response to changes in supply and demand is thought to give a much timelier prognosis on the health of the global economy.
And so, what is copper telling us at the moment?
Price fluctuations
The price of copper fell by about 15% in 2018. However, the plunge occurred entirely between June and August. It rose by 5% in the final three months of the year, despite fears of slowing global growth riling most financial assets, and it is still 4% higher than 18 months ago.
Copper prices are volatile and using a simple statistic such as the annual change would give false signals of a contraction in economic activity. Copper prices also respond to factors other than supply and demand.
A recent study by the Bank of England found that a predictive model based on quarterly changes in industrial metals prices and the previous quarter’s GDP growth did a better job at predicting next quarter’s GDP growth, compared with a model that used last quarter’s GDP growth alone – but only just.
That said, metal prices did predict the surprise increase in global GDP growth in early 2016. Few forecasters at the time expected a rise in global growth.
Three years ago, forecasters’ pessimism in part focused on China, which accounts for 50% of global copper demand.
In 2017, China completed 77 of the world’s 144 new super-tall buildings – more than 200 metres high. By comparison, there are only 113 buildings in New York City’s current skyline in that league.
In fact, we note a strong correlation between the price of copper and our ‘nowcast’ of Chinese GDP growth during the past few years. Our nowcast uses data less susceptible to error and manipulation to calibrate a more accurate gauge of activity than the official GDP numbers.
It currently suggests growth is close to the official figures, although that certainly wasn’t the case in 2015 and 2016.
Interestingly, the strongest correlation occurs when we ‘lag’ our activity indicator by six months; meaing the price of copper seems to respond to Chinese growth with a six-month delay.
Cautious note
Perhaps we shouldn’t rely too much on the reputation of copper for giving us an early diagnosis. High inventories are weighing on industrial output, and export growth has lost momentum, but the latest set of figures reported a modest improvement in spending elsewhere.
Tension between America and China had started to thaw as 2018 drew to a close – but we don’t believe the trade war is over and so remain vigilant.
IN NUMBERS
$2.76
Copper price (lb)
1.6M
Tonnes of copper required over a decade to 2023
10%
Expected copper rally over the next three to six months
Source: Infomine/ BHP/Citi
Ed Smith
Head of asset allocation research, Rathbones
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