Dr. Copper may be in a supercycle, but there are serious problems. In this interview with The Gold Report, Salman Partners’ Vice President of Commodity Economics Raymond Goldie explains why even though the base metal acts pathologically and has a bad case of seasonal affective disorder, these six equities are priced below their intrinsic value.
The Gold Report: You are giving a presentation at the Society for Mining, Metallurgy & Exploration Current Trends in Mining Finance Conference called Diagnosing the Doctor, which refers to assessing the supply and demand problems for Dr. Copper as a way to understand what is ailing all the mining products today. Are we in a supercycle? What is the meaning of a sustainable supercycle?
Ray Goldie: I suppose it’s best to answer your second question first—What is the meaning of a sustainable supercycle?—because a lot of people use the word supercycle to describe the wonderful state that we had beginning in the early part of this century, when metal prices kept going up, commodity prices kept going up, seemingly forever. I’m a little less restrictive on what I define as a supercycle. I think a supercycle is any period in which we have commodity prices higher than their long-term average values. On that basis, even allowing for overall inflation, we’ve been in a supercycle since 2004. We’re still in it, although for a few months regrettably at the end of 2008 we popped out of it. But right now we are in a supercycle.
TGR: What are the fundamentals keeping us in your definition of a supercycle?
RG: The usual reason is China. It’s the biggest consumer of most of the commodities in the world and has the biggest growth in consumption of most of the commodities in the world. But what that analysis tends to overlook is that production of most commodities in China has been increasing at roughly the same rate as consumption in China. So, on balance, China may not be as big a contributor to the supercycle as we’ve imagined.
TGR: Does that mean that the Western world is playing a larger role in supporting the supercycle than we give it credit for?
RG: When it comes to assessing supply and demand from Asia, it is important to consider Chinese economic data, which a recent Bloomberg article equates to some of the meat served in low-cost restaurants. We don’t know where it comes from and don’t really know what it means. It’s not easy to put a lot of credence on Chinese economic numbers, so it’s hard to tell the extent to which China does affect supply and demand.
But one thing that we can count on is the diligence of people who sit at borders with clipboards looking at stuff crossing borders. They are paid to make sure that the right duties get paid and the ships are carrying what they’re supposed to be carrying. If we look at China’s trade with the rest of the world, those numbers are fairly reliable, even if the numbers for what’s going on inside China are not reliable. Since 2008, the dark days when the world seemed to have ended, China’s imports of copper from the rest of the world have grown 41% per annum.
TGR: And what about the supply side?
RG: I think the single most important reason that we’re in a sustainable supercycle is that we haven’t invested enough in finding more resources. The supply-side constraints are probably why prices are higher than the long-term trend in prices.
TGR: Why has it been so difficult to predict how much copper will be produced in a given year if it takes so long to bring a mine to production?
RG: Since about 2003 analysts have consistently overestimated the production of copper. My theory for the consistent shortfall is that before 2003, when strikes, landslides, earthquakes, storms, civil unrest, late trains and the like slowed down production, someone in the head office would send a cable calling for the mining of high-grade ore to make up the difference. But since 2003, there hasn’t been any high-grade ore to mine because of a lack of investment in new resources. And this happens year after year. About 7% less copper is produced each year than the mines predicted at the start of the year.
TGR: So why isn’t that inconsistency causing the price to go up?
RG: Maybe it is. There has certainly been what I’ve called a pathological situation in the copper markets because typically the relationship between copper inventories—the stuff that’s sitting around in warehouses—and prices is that the lower the inventories, the higher the price. But since 2005, in the Western world—we don’t know what’s going on in China—inventories have gone up 185%. Typically, that would mean prices go down, right? But, no, prices have gone up 95%. That may be one of the reasons that we’re consistently producing less of the stuff than we thought we could.
TGR: You have said that the pitch-point™ curve* for supply and demand compared to prices is pathological. Is that because of the role of recycling in meeting some of the demand?
RG: I think it could be because it used to be that every pound that was in inventory was backed by all the copper that the mines would produce and all the copper that scrap yards would produce. The amount that the scrap yards produce has been declining, in large part because Asians have been very diligent about taking scrap from North America and refining it into good usable copper again. But, again, it’s hard to get good figures for how much copper there is in scrap yards so that answer is probably yes, the declining use of copper in recycling is probably one of the reasons why we’ve seen prices go up even though inventories have also gone up. But it’s hard to be more precise than that.
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