In the period immediately following the financial crisis of 2008, copper was on a roll. The reasons were rather simple – everybody was expecting a quick recovery and that copper would soon re-assert itself as the number one industrial metal. Based on these false expectations, Chinese factories stockpiled copper by the thousands of tonnes. This naturally pushed up the price with futures and derivatives based on copper demand, first playing catch-up and then leading the way.
The expected economic recovery did not materialise and even Chinese government stimulus eventually ran out of steam. But more importantly, the large consuming blocks, the European Union and the American market, failed to be resurrected in a significant way. This is most vividly reflected in the stunted growth in international trade, especially over the past year.
International trade continued, but the volumes did not grow, so the anticipated growth in demand for copper did not materialise. The required volumes remained static and eventually started declining marginally. Meanwhile, the Chinese power house was running full-steam ahead using thousands of tonnes of stockpiled copper. Eventually, the stockpiles stopped growing, even declining and the demand at primary level collapsed. When the markets cottoned on that Chinese manufacturing has run out of steam, the copper price started to decline in tandem with a range of other commodities.
We are painfully aware of what this has done to producers, declining from around US$5 per pound in the heyday to only US$2.20 per pound a few weeks ago when the turmoil in Chinese markets started. This is most visible in the copper futures market where contracts are taken out for batches of 25,000 pounds of physical copper delivery at a set future date, but which hardly ever reaches the execution stage. In other words, copper futures are purely an investment instrument, and as such is prone to just as much speculation as any other futures contract.
For speculative traders this may be a good thing, or at least it provides some opportunity to claw back lost value from dealing in copper futures. But when copper futures move more than 2% a day, either up or down, especially since about the second week in August, it shows me something is amiss.
The output problems experienced at Chinese factories are not something only realised at the beginning of May this year when copper started its latest decline. At the physical level on the factory floor, the building up of inventory started over three years ago. As inventories grew, so the stockpiles remained static. But Chinese industry had to keep producing for reasons that have little to do with demand and sales. The value chain pulled back and as has happened with many other industrial commodities, the price for physical copper declined. This spilled over to the futures and derivatives market, eventually leading to the substantial losses metals traders became exposed to.
I think the most important lesson for developing countries is that commodity prices are not set by real demand and output. They are almost entirely based on derivatives that base their value on perceived future demand. On the factory floor, over-production only becomes apparent with time, often very long times measured in years instead of months. The financial markets however, are much quicker to respond, but in doing so, the movements are not based on actual inventories or actual production levels, but on sentiment.
The world’s primary copper producers, same as other industrial metals producers, are at the mercy of financial markets. This is very harmful to stability in primary industries and particularly harmful to those countries that depend on the export of their minerals.
When copper futures rise by more than two percent in 24 hours something serious is wrong. The demand for copper did not change by the same percentage in such a short period. When copper prices slide again the very next day, it can not possibly indicate that inventories have grown inversely or that factory output has collapsed overnight. This is patent nonsense but it illustrates the degree to which the developing world is held hostage by international traders.