After breaking through the high of $11,000 per ton, copper prices have given back most of their gains, with the current price of $8,900 per ton only a step away from the starting point of $8,500 per ton. If the initial surge in copper prices was a self-fulfilling prophecy of the market's long-term expectations, then the subsequent decline can be understood as a market correction. Behind the early rise in copper prices, on one hand, there was the influence of interest rate cut expectations, and more importantly, the market was pricing in the tight supply and demand fundamentals of copper for the current and next year. However, in retrospect, copper prices moved ahead of the fundamentals, with strong signs of negative feedback from demand, indicating that downstream industries were not ready to accept the record-high copper prices. Moreover, as the timing of interest rate cuts approaches, there is insufficient room for rate cut trades but ample space for recession trades, and the copper supply and demand balance may face challenges directly. Nevertheless, the swinging macroeconomic expectations do not affect our optimistic judgment on demand in areas such as electricity and new energy, and the increase in copper consumption driven by electrification remains the main upward pull for copper prices. On the other hand, the sustainability of mine releases is limited, and the risk of loosening support for the bottom of copper prices is relatively small. Overall, we believe that the risk of a significant deterioration in the copper balance sheet is relatively small, and if recession expectations intensify, this may help copper prices to land softly.
Summary
The decline in copper prices is the convergence of expectations and reality.
From the perspective of commodity attributes, the negative feedback of demand on high copper prices is quite evident. In the first half of the year, the gap between copper reality and expectations did not close but instead widened as copper prices continued to rise. The speed at which marginal demanders left the market exceeded market expectations. We believe that the sources of negative feedback from downstream on high prices are mainly threefold: First, on the investment side, the overall annual power investment budget has limited room for increase, and the rise in copper prices leads to a tendency for "two networks" to postpone procurement orders; Second, the rise in upstream raw material prices represented by copper is largely driven by the prosperity of the midstream production, but the price increase comes at the expense of midstream profits, and the transmission to the downstream is not smooth. Midstream profit pressure, in turn, will suppress the upward space for copper prices. Third, under high prices, the willingness to replace copper with aluminum in some low-voltage cables has also increased.
From the perspective of financial attributes, interest rate cut trades have been fully priced in, and recession risks have subsequently heated up. At the critical point where the United States is about to cut interest rates for the first time, the market faces economic data that falls short of expectations, and there is limited room for further enhancement of monetary policy easing expectations, but concerns about a hard landing may deepen significantly. There is insufficient room for interest rate cut trades but ample space for recession trades, which is also the main logic behind the general weakness of copper prices 90 days before the first interest rate cut in each Federal Reserve interest rate cut cycle. Previously, the United States' second-quarter GDP and private final sales growth were robust. The steady downward trend of core PCE has gradually strengthened the expectation of "preventive shallow interest rate cuts." However, the U.S. non-farm data in July was unexpectedly weak, and the U.S. unemployment rate in July also unexpectedly rose to 4.3%, and interest rate cut trades began to show signs of switching to "recession trades."
For copper prices, on one hand, after the full pricing of easing expectations, the net long position of LME copper investment funds has significantly declined since June, and market pricing has gradually returned from financial attributes to commodity attributes. On the other hand, as recession trades heat up again, copper will inevitably face certain selling pressure in the short term. However, we believe that the copper balance sheet remains robust, and after speculative premiums are cleared or even oversold, the supply and demand gap may support copper prices to stabilize and rebound.
It is difficult for supply releases to be sustainable, and transformational demand is resilient.
Raw material supply constraints remain, and reductions in smelting in the fourth quarter may be implemented. In the first half of this year, the contradiction between mining and smelting fermented, but reductions in smelting did not materialize, and domestic refined copper production still maintained a high growth rate. We believe this is due to the high prices of long-term contracts previously agreed upon and the increase in scrap copper supply. The growth rate of copper concentrate supply also recorded a high growth rate (January-May: 4.2% YoY), mainly due to the capacity release of some newly commissioned projects and the low base effect. However, looking at the whole year, we believe that the constraints on copper smelting raw materials still exist, copper mine supply remains tight, high growth may be difficult to maintain, and the increase in scrap copper may also not be sustainable. We expect that reductions in smelting may be implemented as early as the fourth quarter.
Looking ahead, we maintain the views from our mid-year outlook, that copper still faces structural and irreversible long-term supply risks, including the continued sluggishness of capital expenditure, the aging of existing mines, deglobalization, and resource protectionism. Combining our review of mining and smelting in the text, we expect that the possibility of unexpected recovery on the supply side in the short term is also low, and the room for supply relaxation trading is limited.
Broad electrification consumption increases to offset the slowdown in traditional demand, and there is no need to be too pessimistic about demand. Recently, the global manufacturing prosperity has marginally weakened, and with the continuous downturn in real estate, market concerns about the prospects of copper demand have also increased. However, the increase in broad electrification consumption is still offsetting the slowdown in traditional demand, and the combined demand for power grids, wind and photovoltaic, and new energy vehicles has reached 45% of China's existing copper demand, so we are not pessimistic about copper consumption this year. Power investment remains the cornerstone of copper demand. We expect that the investment in power grid projects this year is expected to maintain a high growth rate and tilt towards the distribution end with higher copper consumption intensity. We believe that the growth of power grid copper demand is still expected. On the power source side, considering that the marketization of new energy consumption is expected to open up the space for wind and photovoltaic installations, we are also not pessimistic about the sustainability of new energy demand growth. On the consumer side, although global sales of new energy vehicles face certain pressures this year, the steady increase in the amount of electricity per vehicle will also help increase copper consumption. In terms of home appliances, although domestic sales have weakened, exports and consumer goods replacement policies may support the prosperity of white goods production after implementation.The copper balance sheet remains relatively robust, and a "soft landing" for copper prices is expected.
In terms of the balance sheet, we do not change our judgment on the copper supply and demand balance for 2024, which is a slight global shortage of 140,000 tons for the whole year. In terms of prices, looking at the current copper prices with a "cost + premium" valuation system, they have returned to a relatively reasonable range. The cost for 2024 (90th percentile of the copper cash cost curve + sustaining capital expenditure) is approximately $6,523 per ton, and the current premium rate has narrowed from a high of 60% earlier in the year to 35%.
The "premium" can be seen to some extent as the profit space for the entire copper industry chain, including copper mines and smelters, to play a game with the downstream. It is mainly affected by the copper supply and demand balance and global liquidity. Looking back at history, the median premium rate since 2000 has been 20.6%, but in years when supply and demand are tight or slightly short, the median premium rate is 36.6%, similar to the current level. Therefore, with the fundamentals of copper still relatively robust, we believe that the possibility of copper prices falling below $8,000 per ton (corresponding to a 22% premium rate) is relatively small. From another perspective, historically, maintaining a high premium of over 50% for a long time requires extremely strong demand (such as the large amount of infrastructure and real estate investment demand in China from 2006-07) or extremely abundant liquidity (such as the Fed's QE1-2 during 2010-11, and QE4 in 2021). In our medium-term outlook, we obviously underestimated the negative feedback brought by high prices. Therefore, although we remain optimistic about copper prices in the medium and long term, the market does not have the conditions to accept high copper prices in the short term.
Main text
After breaking through the high of $11,000 per ton, copper prices have given up most of the gains, and the current price of $8,900 per ton is only a step away from the starting point of the market at $8,500 per ton. If the rush in copper prices is the market's long-term expectation being self-fulfilled in the present, then the decline in copper prices can be understood as the market's self-correction. Behind the previous rise in copper prices, on the one hand, it was driven by the expectation of interest rate cuts, and more importantly, the market was pricing the tight supply and demand fundamentals of copper for this and next year. However, looking back, copper prices have moved ahead of the fundamentals, and there are strong signs of negative feedback from demand, indicating that the downstream is not ready to accept the record-high copper prices. Moreover, as the timing of interest rate cuts approaches, there is not enough room for interest rate cut transactions but plenty for recession transactions, and the copper supply and demand balance sheet may face challenges. However, the swings in macro expectations will not affect our relatively optimistic judgment on demand in areas such as electricity and new energy. The increase in copper consumption driven by the rise in electrification demand is still the main upward pull for copper prices. On the other hand, the sustainability of ore release is limited, and the risk of loosening the bottom support of copper prices is small. Overall, we believe that the risk of a significant deterioration in the copper balance sheet is relatively small, and if the expectation of recession intensifies, it may help copper prices to land softly.
The decline in copper prices is the convergence of expectations and reality.
From the perspective of commodity attributes, the negative feedback of demand on high copper prices is more obvious.
Ore constraints → demand recovery → squeeze transactions, the first half of the year's bullish cycle. On March 13, the China Nonferrous Metals Industry Association organized a symposium for copper smelting enterprises to discuss capacity control issues [1]. To some extent, this means that the ore-smelting contradiction has begun to become explicit, and it has also opened the prelude to the first half of the year's rising market. In April, although the absolute value of imported TC has dropped to a single digit, domestic smelters have not yet reduced production. At the same time, the manufacturing PMI of China and the United States both rose to the expansion range above 50 in March, driving the global manufacturing PMI to the highest point in 23 years, and the expectation of a global manufacturing recovery is gradually strengthening. In May, the tug-of-war between bulls and bears intensified, and the momentum for COMEX squeeze transactions began to brew, with copper prices and speculative net long positions reaching their highest point on May 20.
However, the gap between reality and expectations has not been bridged, but has widened as copper prices have continued to rise. Since May, the manufacturing PMI in Europe and the United States has slowed down marginally, and demand weakness has begun to emerge. Copper inventories on the three major global exchanges have continued to rise, and as of August 2, the total inventory of the three major global exchanges was 561,000 tons, up 59.9% from the beginning of the year and up 120.6% from the same period last year.
Domestically, the rise in copper prices has been accompanied by a deepening of spot discounts and a significant accumulation of inventories. At the end of May when copper prices peaked, the domestic copper spot discount once reached 340 yuan per ton. Domestic social refined copper inventories accumulated counter-seasonally. From the perspective of copper processing, the negative feedback of demand brought by high copper prices is also more obvious, and the SMM copper processing start-up rate is comprehensively lower than the seasonal level. The price difference between refined copper inside and outside widened, the import window closed, and the Yangshan copper premium, which is considered an important indicator of the strength of China's import demand for refined copper, fell to a negative value for the first time in history. In June, net refined copper imports were 130,000 tons, a year-on-year decrease of 50%. From various signs, downstream demand may not be ready to welcome the new high of copper prices, and the speed at which marginal demanders leave the market has exceeded market expectations.We believe that there are three main sources of negative feedback from downstream on high prices. First, on the investment side, the upward space for the overall annual electricity investment budget is limited, and the rise in copper prices makes "the two networks" tend to postpone purchase orders. Second, the rise in upstream raw material prices represented by copper is largely driven by the prosperity of the midstream production, but the price increase comes at the expense of midstream profits, and the transmission to downstream is not smooth. The midstream profit pressure in turn will also suppress the rise of copper prices. Third, under high prices, the willingness to replace copper with aluminum in some low-voltage cables has also increased.
From a financial perspective, the interest rate cut has been fully priced in, and the risk of recession has heated up. At the critical point when the United States is about to cut interest rates, the market faces economic data that is not up to expectations. The space for further easing of monetary policy expectations is limited, but the concern about a hard landing may deepen significantly. The interest rate cut transaction space is insufficient, but there is enough for a recession transaction. This is also the main logic behind the general weakening of copper prices 90 days before the first interest rate cut in each Fed interest rate cut cycle. Previously, the second quarter GDP and private final sales of the United States grew steadily. The steady decline of core PCE has gradually strengthened the expectation of "preventive shallow interest rate cuts". However, the U.S. non-farm data in July was weaker than expected, with the seasonally adjusted non-farm employment population recorded at 114,000, the smallest increase since April 2024, far below the expected 175,000. The U.S. unemployment rate in July also unexpectedly rose to 4.3%, triggering the "Sam Rule". The "interest rate cut transaction" has begun to gradually show signs of switching to a "recession transaction".
For copper prices, on the one hand, after the easing expectations have been fully priced in, the net long position of LME copper investment funds has significantly declined since June, and the market pricing has gradually returned to the commodity attributes from the financial attributes. On the other hand, the recession transaction has heated up again, and copper will inevitably face certain selling pressure in the short term. However, we believe that the balance sheet of copper is still robust, and the supply and demand gap may support the copper price to stabilize and rebound after the speculative premium is cleared or even oversold.
The supply release is difficult to sustain, and the transformation demand still has resilience. The raw material supply constraint still exists, and the reduction in smelting may be implemented in the fourth quarter. In the first half of this year, the contradiction between mining and smelting intensified, but the reduction in smelting did not take place, and the domestic refined copper output still maintained a high growth rate. We believe this is due to the high prices of the long-term contracts previously signed and the increase in scrap copper supply. The growth rate of copper concentrate supply also recorded a high growth rate, mainly due to the release of capacity of some newly commissioned projects and the low base effect caused by disturbances such as strikes in Peru and floods in Indonesia last year. However, looking at the whole year, we believe that the constraint of copper smelting raw materials still exists, copper mine supply is still tight, high growth may be difficult to maintain, and the increase in scrap copper may also be difficult to sustain. We expect that the reduction in smelting may be implemented as early as the fourth quarter.
In terms of copper mines, although the closure of Cobre Panama and the reduction of Los Bronces in the first half of the year had an impact on the output of copper concentrate, according to ICSG statistics, the global copper concentrate output from January to May reached 9.25 million tons, a year-on-year increase of 4.2%. This is mainly due to the release of capacity of expansion projects such as QB2 and KFM, plus the low base effect caused by disturbances such as strikes in Peru and floods in Indonesia last year.
We expect the situation of copper mine supply to become tighter on the margin, and the growth rate of copper concentrate supply in 2H24 may fall to 1.6%. In terms of incremental capacity, only the third phase of Kamoa-Kakula was put into operation in the first half of this year. In terms of existing capacity, according to the output guidance announced in the second quarter reports of the world's major copper mining companies, the copper concentrate output in the second half of the year will increase and decrease. In terms of reduction, Teck Resources has lowered its annual copper output guidance from 465,000 to 540,000 tons to 435,000 to 500,000 tons, mainly due to short-term passage obstacles caused by mine dewatering and local geotechnical issues, which may lead to a decline in the output of the Quebrada Blanca mine [2]. Codelco has not revised its annual output guidance, but Codelco's copper output in the first half of 2024 decreased by 8.4% year-on-year to 580,000 tons. Rio Tinto and Antofagasta are expected to have annual output at the lower end of the guidance.
In terms of increment, Southern Copper has raised its annual output guidance from 949,000 tons to 963,000 tons. Minmetals Resources expects its main mine, Las Bambas, to reach the upper end of the guidance. The rest, including Freeport, Anglo American, First Quantum, Glencore, Ludin and other mines, maintain the annual output guidance unchanged.The copper balance sheet remains relatively robust, with a "soft landing" for copper prices expected.
In terms of the balance sheet, we do not change our assessment of the copper supply and demand balance for 2024, which is a slight global deficit of 140,000 tons for the year. Regarding prices, looking at the current copper prices through a valuation system of "cost + premium," they have returned to a relatively reasonable range. The cost for 2024 (90th percentile of the copper cash cost curve + sustaining capital expenditure) is approximately $6,523 per ton, and the current premium rate has narrowed from a high of 60% earlier in the year to 35%.
The "premium" can be seen to some extent as the profit margin in the game between the entire copper industry chain, including mining and smelting enterprises, and downstream players, mainly influenced by the copper supply and demand balance and global liquidity. Looking back at history, the median premium rate since 2000 has been 20.6%, but in years with tight or slightly deficient supply and demand balance, the median premium rate is 36.6%, similar to the current level. Therefore, with the fundamentals of copper still being relatively robust, we believe the possibility of copper prices falling below $8,000 per ton (corresponding to a 22% premium rate) is quite small. From another perspective, historically, maintaining a high premium rate of over 50% for a long period requires very strong demand (such as the substantial infrastructure and real estate investment demand in China during 2006-07) or very abundant liquidity (such as during the Fed's QE1-2 in 2010-11, and QE4 in 2021). In our medium-term outlook, we have clearly underestimated the negative feedback from high prices. Therefore, although we remain optimistic about copper prices in the medium to long term, the market does not currently have the conditions to accept high copper prices in the short term.