Is Dr Copper Making A Fool Out Of Us?
A favorite trick of global macro commentators, and some traders, is to look at short term price action in a particular market and from there extrapolate broader economic conditions, which they then use to make other forecasts.
Copper is a perfect example of this.
Dubbed “Dr. Copper” (the PhD kind) by market folk, copper prices are seen as a leading indicator of the global economy’s health because of how widely it is used across industrial economies; power generation, construction, electronics, and telecommunications, to name a few.
The logic runs that higher prices for copper = higher demand from across industrial economies, therefore massive economic growth. BUY BUY BUY!
While copper’s cyclical price moves are correlated with global growth over the long term, such linear, reductive thinking does not really work well when it comes to short term market movements.
Copper is no exception, and its price is much more than a function of demand driven by global economic growth.
For example, what about supply?
Demand cannot be considered in isolation, it must be seen relative to supply. In the case of copper, supply in 2020 was affected pretty adversely by the spread of Covid simply due to two countries accounting for 40% of global production.
Chile and Peru, the first and second producers respectively, both had a very difficult time dealing with both the first and second waves of Covid in 2020, with lockdowns and concerns about the health of miners curtailing production.
As such, it isn’t surprising that forecasts for 2020 production stand at around -1.5% according to the International Copper Study Group.
Which brings us to the economic situation post April 2020.
As lockdowns rolled across the globe in the first quarter of last year, global economies shut down, leading to that now forgotten sharp and vicious move lower across global financial markets.
With immediate threats to employee health, frantic government actions to control the spread of Covid, and an extremely uncertain outlook for the future, miner’s cut their production.
Then Western governments decided to open their countries and economies again as spring turned to summer, and demand came rushing back.
However, demand didn’t rush back due to a rosy and robust global economy, but instead from the reopening of economies and the restart of previously mothballed industrial activity.
This left the copper market with producers seriously struggling, while demand rebounded like a coiled spring being released.
As an example of how dire the supply situation was at the peak of last year’s supply shock, Peru’s production dropped 38% over April and May 2020.
There simply was no way producers could keep up with rebounding demand from the world’s reopening.
In other words, one hell of a short squeeze.
Markets and economies are extremely complex – do not conflate the short term price moves of an asset with the general state of the broader economy!
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