21 Sep 2022 4 min read

Dr. Copper will see you now

By Patrick Greene , Christopher Jeffery

Supported by heightened demand from the green transition, the long-term outlook for copper is encouraging. But with developed markets braced for recession, the short-term picture is far less encouraging.

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A wise old investor once said we should listen carefully to Dr. Copper. Industrial demand for the red metal means copper prices have historically been geared to the global industrial cycle.

So, what can we learn from ‘the metal with a PhD in economics’ given that it’s down nearly 20% year-to-date?1

Copper calls it correctly

The market term ‘Dr. Copper’ stems from the metal’s ability to sometimes provide an early warning indicator at important cyclical inflection points. The last two global downturns provided good examples of copper’s soothsaying abilities.

In 2008, copper prices fell alongside equities as the global financial crisis took hold but bottomed out almost three months before the equity market in early 2009 as coordinated global stimulus turned the tide on the recession. In 2020, copper prices started sliding in January as stories started to emerge of a mysterious virus circulating in China. Equity markets didn’t peak until late February.

No leading indicator is infallible, but copper’s track record is respectable enough that it is important to understand whether price changes are signalling information about the global cycle that has not yet been fully reflected in other asset prices.

The diagnosis

Dr. Copper appears to be giving us another warning: benchmark copper prices are down almost 20% year-to-date and nearly 30% from the peak in March.2

This time around the signal was more coincident or lagging other risk markets, with Russia’s invasion of Ukraine causing a late surge in copper prices. But demand concerns have dominated since then. Recurring COVID-19 outbreaks and property sector troubles have led to weak Chinese growth. In developed markets there is a high probability of a recession. Copper is highly cyclical and exposed to these slumps in demand.

Does that mean copper is signalling a recession?

Not entirely. As well as weaker demand, the copper price is also likely starting to reflect faster supply growth this year and next. That will lower the price, regardless of the global economy.

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There are also those who think Dr. Copper is changing PhD topic.

Copper turns green

Copper is a key input in the green transition. Electric vehicles, wind and solar all use more copper than their fossil fuel-based alternatives. This is likely to cause a continued period of strong demand growth for copper.

But supply looks set to fall short. Having been through a boom in the 2000s and experiencing the bust in 2010s, miners are much more reluctant to spend big on new projects this time around. Instead, they are focused on generating returns and returning capital to shareholders.

Miners are contending with falling copper grades (lower concentrations of copper in the locations where they are mining). This increases costs and forces miners to look in less conventional locations. Unconventional locations often come with greater risks.

There are also local environmental, social and governance (ESG) concerns. Although copper is crucial for the global energy transition, copper mines are bad for the local environment and often meet resistance. Where copper mines are permitted, regulations to meet the highest ESG standards are further increasing costs. All this creates a long-term supply and demand picture that points to higher prices.

Summarising the thesis

The challenge for investors looking to take advantage of copper’s exposure to the long-term energy transition is a negative short-term picture. Long-term supply looks constrained, but we believe 2023 will see a short-term surge in supply, at a moment of demand weakness.

That leaves us believing the risks are skewed to the downside over the next 12 months. When thinking about how big that downside is, we look at the marginal cost curve of existing projects. We would use a copper price dropping below the 90th percentile of the cost curve (so 10% of existing mines are not making money) as a good starting point for investing in miners with good copper exposure. 

If we see prices fall below that fundamental level, or if pessimism about the global economy overwhelms Dr. Copper, it could potentially create a good entry point for long-term investors more interested in the doctor’s growing green credentials.  

1. Source: Bloomberg as at 12/09/2022

2. Source: Bloomberg as at 12/09/2022

Patrick Greene

Strategist

Patrick is a strategist within LGIM’s Asset Allocation team, covering a range of asset classes. Patrick joined LGIM in 2021 from M&G, where his most recent role was in the Long-Term Investment Strategy team, covering both macroeconomic research and investment strategy. Prior to that, he was an economist at CRU, providing economic research relevant to commodity markets. Patrick graduated from Durham University with a degree in economics. He also holds an MSc in economics from Trinity College Dublin and the Investment Management Certificate.

Patrick Greene

Christopher Jeffery

Head of Inflation and Rates Strategy

Chris works as a strategist within LGIM’s asset allocation team, focussing on discretionary fixed income and systematic risk premia strategies. He coordinates global rates and inflation strategy across LGIM’s asset allocation and fixed income capabilities. He joined LGIM in 2014 from BNP Paribas Investment Partners where he worked as a senior economist and strategist within the Multi-Asset Solutions group. Prior to that, he worked as an economist within monetary analysis at the Bank of England with a focus on the UK domestic economy. Chris graduated from University College, Oxford in 2001 with a first class degree in philosophy, politics and economics. He also holds an Msc in economics (research) from the London School of Economics and is a CFA charterholder.

Christopher Jeffery