Real Asset Strategy
Timely discussion of the recent commodity, REIT, and real asset markets and what it may mean for investors.
John LaForge, Head of Real Asset Strategy
Why We See Lower Copper Prices in 2018
- 2016 and 2017 were great years for copper prices, likely due to better economic expectations and copper demand from China.
What it may mean for investors
- Despite this fact, we doubt that copper prices will rise again in 2018. Much of the good Chinese news already appears “baked into” copper prices.
“Sudden events cannot be handled by the unprepared mind.”
We often discuss how the super-cycle impacts commodities as a family and how super-cycle bear markets last 20 years on average. In today’s report, we will review what that bear super-cycle looks like for oil, what forces are conspiring to keep oil prices range-bound for years to come, and what would need to happen for a bull market to begin.
In 1990, China accounted for less than 5% of world copper demand. Twenty-seven years later, in 2017, China accounts for nearly 50% (Chart 1, orange line).
So, when we’re asked why copper prices have risen 24% in 2017—our first instinct is to look at demand trends inside China. It turns out that China has been accumulating more copper. Yet, some of the charts we’re about to show you suggest that copper’s run may soon be done.
2017 was the second year in a row for copper price gains. In 2016, copper prices rose 17%. This was after six straight down-trending years, from 2010 through 2015. Chart 2 highlights why copper prices may have followed such a wild path over the past eight years. The blue line represents China’s gross domestic product (GDP) year-over-year growth rate. The orange line is the price of copper, year-over-year. Notice that China’s GDP growth rate was cut in half from 2010 through 2015, from 12% to roughly 6%, and copper prices followed suit. A bit later in this report, we’ll tackle why we believe copper prices have been rallying since 2016, while China’s GDP growth rate has risen only slightly.
China’s GDP growth rate plunged from 2010 through 2015, largely because the country slowed its building of everything from roads and bridges to buildings. This slowing was mandated by the government’s five-year plan, released in 2011, with details discussed in 2010. China’s five-year plan is a series of social and economic development initiatives. Why the 2011 plan was so significant to building, and ultimately copper prices, was that the plan emphasized “consumer-led” growth over “building” or “capital-type” growth (also known as capital expenditures). The 2011 plan was a sea change from the prior decade, which stressed “capital-type” growth. The blue line in Chart 3 shows China’s ratio of “capital” to “consumer” GDP growth. A rising blue line means that China’s “capital-led” GDP growth is exceeding its “consumer” growth. A falling blue line denotes the opposite; that “consumer” growth is outpacing “capital” growth.
Why China decided to emphasize “consumer” over “capital” growth in 2010 and 2011 is best answered by the Chinese government. Our best guess, though, is that the government decided that it wanted to be recognized as a developed country rather than as a developing country. As this relates to GDP, developed countries generate most of their GDP from the consumer, not from capital. U.S. GDP (Chart 4, red line), for example, was about 65 percent consumer and 35 percent capital, in 2010. In 2010, China’s GDP mix (Chart 4, blue line) was the reverse—roughly 35 percent consumer and 65 percent capital.
So, let’s go back to the question of why copper prices have risen so significantly since 2016, while China’s overall GDP growth rate has risen only slightly. Part of the answer has nothing to do with copper—but instead—with the reality of lower GDP growth rates in countries as they become more mature, and more consumer-driven. Unfortunately, consumer-led GDP growth tends to come with lower GDP growth rates, as many a developed country can attest. In other words, it is hard to move the growth needle higher as a country matures.
With that said, China’s GDP growth rate technically has risen over the past two years (Chart 2, blue line), which has been a marked change from the 2010-2015 period. Part of the copper price bounce, since 2016, may very well have been linked to the fact that China’s GDP growth rate had stopped falling. There is no question, though, that China has been buying more copper in recent years, which has impacted the price. The orange line in Chart 5 is the price of copper, while the blue line represents China’s net copper imports.
So, the question still remains—why is China buying so much more copper in recent years, with its GDP growth rate only marginally higher? The answer may lay in future economic expectations. Chart 6 shows the year-over-year change in copper prices (orange line), versus the year-over-year change in the China Business Cycle Signal (blue line). This signal has been a leading indicator for China’s economy. Its rise, since 2016, suggests a pickup in Chinese GDP in the coming years. The connection between the price of copper and this leading economic index is not always perfect, but it has been a tight one in recent years.
If one of China’s leading economic indices is suggesting better times ahead, why are we saying that copper prices may be set to fade in 2018? Our answer is tied to Chart 7, which plots this same leading Chinese economic index against actual Chinese GDP growth. Notice that most of the time, since 1992, the leading economic index did a good job of calling the direction in GDP growth—but not in the past few years.
We suspect that something has to give with Chart 7; either China’s GDP growth picks up, or its leading economic indicator turns back down. Neither of these scenarios seems likely to lead to meaningfully higher copper prices in 2018. Chart 6 suggests to us that copper prices already have priced in the likelihood that the leading economic index is right. For copper prices to move meaningfully higher from here, we likely would need to see another step-up in the leading economic index. This is always possible, but it probably is a stretch, considering that today’s index reading sits at its highest level, since 2010. And then there is the scenario that the leading index is wrong, or at the least, ahead of itself. If so, watch out below for copper prices, again, based on the connection that we see in Chart 6. Lastly, China has not changed its long-term plans to stress consumer-led growth over capital-led growth, and we doubt that it will. Copper, and other industrial metals, will be fighting this long-term headwind for years to come. Our copper bottom line for 2018— we’re expecting lower prices.
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China Business Cycle Signal Index is considered a leading index released by the National Bureau of Statistics of China. It is used for monitoring the situation of the macro-economic performance and forecasting the trend of future development. The index takes into account measures of: industrial production, fixed asset investment urban cumulative, retail sales, exports, imports, government revenue, per capita urban disposable income, loans from financial institutions, m2, cpi, and industrial profits.
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