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Copper prices have crashed in recent days amid growing panic over the impact of the coronavirus, and the metal’s reputation as a barometer for the global economy means analysts are looking to see if it has further to fall.
On Thursday, copper prices hit their lowest level since January 2016, with three-month copper futures on the London Metal Exchange (LME) touching $4,371 per metric ton. That’s down from a high of around over $6,340 in mid-January. By 6.30 a.m. London time, copper prices were trading around $4,548.
It comes amid the coronavirus pandemic, with over 215,000 confirmed cases around the world, according to Johns Hopkins University, and over 8,800 recorded deaths. The fast transmission of the disease has seen both stock and commodity markets tank as businesses shut down, first in China and now in the U.S. and Europe, and people are told to stay indoors.
Here, we take a look at two charts that indicate copper could have further to fall.
The copper/gold ratio sees copper prices in ounces divided by gold prices in ounces. It is used as a “growth-to-fear proxy” as both copper and gold are mined in similar ways and have similar production cost structures. Max Layton, head of EMEA commodities research at Citi, explained that copper producers tend to make money when global growth is strong, and gold producers tend to make money in periods with high levels of fear, for example, post-recession.
“What you end up with is this growth proxy in the copper margin, versus a fear proxy in the gold margin. So if you take them as a ratio, it’s basically: when it goes down it’s because growth is low and fear is high, and when it goes up it’s because growth is strong and fear is relatively low,” he told CNBC.
In this chart, the copper/gold ratio is illustrated alongside the 10-year Treasury yield. Sovereign bonds are typically viewed — like gold — as a safe-haven investment. As such, bond prices, which move inversely to yields, tend to rise at a time of economic uncertainty, and yields fall.
Amid massive volatility on stock markets over recent weeks, the flight to bonds has seen the yield on the 10-year Treasury note hit record lows, although it has ticked up slightly over recent days. On Thursday morning, the yield was trading around 1.2311%.
The relationship between bond yields and the copper/gold ratio, “historically holds together pretty strongly,” Layton said, adding that the fact that yields have fallen more sharply than the copper/bond ratio, “suggests that the fear being priced into bond markets is greater than the fear that’s being priced into copper and gold markets.”
Citi has reduced its price forecast for copper to $5,000 per metric ton for the next three months.
Oil prices have also collapsed over recent weeks, on the back of both growing fears about the economic impact of the coronavirus and a failure to agree on supply cuts — which would have bolstered prices — by major producers Saudi Arabia and Russia.
In this chart, there is a clear correlation historically between the price of Brent crude and the price of copper.
The commodities are related for two main reasons, according to Layton: Firstly, their demand is linked to global economic growth and activity; secondly, the price of oil influences the marginal cost of producing copper as oil is used throughout the mining process.
The fact that oil prices have fallen more sharply than copper prices indicates the latter has further to fall.
“Copper producers are, over time, going to have a lower cost of production due to this lower oil price — and all else equal, this will put downward pressure on the copper price,” Layton said.
“If your marginal cost of production falls then the producer margin is increasing for a flat copper price, and there’s no fundamental reason why the producers should be getting a stronger margin … So what will happen is the price will chase the marginal cost down.” Producers won’t be able to justify their higher margins to buyers, and so will have to lower the price of copper accordingly.
Citi isn’t the only bank that is expecting copper prices to continue falling.
On Tuesday, Goldman Sachs substantially revised down its three-month copper forecast to $4,900 per metric ton, from $5,900. Analysts at the bank led by Jeffrey Currie said in a note Tuesday that although financial markets were likely to rebound once the ongoing contagion stabilizes, “commodity markets are spot assets and must clear the surpluses developing today from weak demand and rising supply.”
Dr. Copper?
Copper’s reputation as a barometer for the global economy means its outlook is always closely watched. It’s viewed this way because of its broad range of end-uses — both in construction and in consumer products such as cars and consumer appliances.
As such, an economic downturn or recession, which typically sees construction grind to a halt and consumers stop spending, hits demand for copper, and so prices for the metal, hard.
But Citi’s Layton flagged that it’s more than this — like gold, the perception of copper as a barometer impacts the way its price moves. Often investors and machine-led hedge funds trade copper because of its historical perceived link to the macro economy more than they trade the other metals.
“Therefore, when you get bearish environments, or bullish environments, copper tends to attract … short positioning in bear markets and long positioning in bull markets,” he added. If an investor holds a short position in copper, they’re betting the price will fall in the short term and plan to buy it back at a lower price.
