Copper price have fallen to levels which are close to estimated cash cost levels for high cost producers, with some speculating that production cuts may support prices. This sentiment is summed up in this
FT article, which seems representative of the initial mood at CESCO, the world's biggest copper conference.
Relying on price driven supply side dynamics to push prices higher has proven very hazardous across a number of commodities, with the experience of aluminium, thermal and met coal and platinum producers suggesting that costs are irrelevant from a short to medium term perspective. Iron ore has proven to be different, with marginal supply much more flexible than in other commodities. However, we don't know whether this is true for copper and in my view is not a safe assumption when considering the direction of prices.
A cursory glance at aluminium fundamentals over the past few years suggests large oversupply despite prices being well below estimated costs. Production growth has slowed, but nonetheless remained positive since prices have slipped below estimated marginal costs.
Production growth has perhaps been supported by premiums for delivery, which are captured by most producers. Even still, trading on a cost-curve view would mean you have still lost significant amount of money.
Production cuts are beginning to happen in aluminium, although to some degree these losses are being replaced by lower cost production.
To be sure, cost curves are not static. The FT article mentioned above has the sub heading "
High-cost producers must cut output or sustain losses", but recent experience across a range of commodities suggests they actively look to improve productivity.
This is to some degree the experience of thermal and met coal, where high cost Chinese supply has been shown to be not as high cost as previously envisioned.
For thermal coal, this is partly because the highest cost part of the curve is no longer required, partly because demand was weak, but also because transport costs improved with increased rail capacity.
For coking coal its not as apparent that this is the case as demand has been better than expected in 2013. Nevertheless, apparent Chinese supply continues to grow at a reasonable clip despite disastrously low prices. This seems to be more of a failure to understand mine costs rather than a displacement of higher cost supply.
South African platinum producers provide a valuable lesson that a slow rationalisation in higher cost supply won't turn around prices if demand is also mostly drifting sideways.
Indeed, the first response in this case was not to cut higher cost output, which means a large loss on invested capital, but rather to increase production with the same inputs to reduce average costs. This, ultimately, is not helpful to the market balance.
Iron ore is one commodity where we have seen meaningful movements in high cost supply as prices have faded, particularly at the end of 2012. Indeed, this seems to be the most flexible cost curve across metals and bulk commodities.
Price fadeouts have tended to be short in nature more recently, partly because of very big movements in inventories that have required restocking, but also because end use demand has bounced back.
But there is good reason to think that they may stay out of the market if price weakness persists longer than 3 months, as their cost disadvantage is to a large degree geological given low ore grades.
So is copper more like iron ore or most other bulks and metals? At this stage its hard to know, because copper has not tested any part of the cost curve since the huge downturn in 2008/09, which was an entirely different scenario to now.
But making production cut backs central to a trading strategy is far too risky. Rather, its better to appeal to more tried and tested visible indicators of demand and supply.
On the front, there are still some areas of concern. Chinese interest continues to weak with premiums crashing. Historically that has not been a bad sign for copper, with LME prices inversely related to Chinese copper premiums. But that has usually been driven by strong ex-China demand and slow mine supply growth.
Ex-China demand is growing, although is not soaring as
evidenced by the inflection point seen in recent PMIs. Supply is also growing more strongly, although there have been some disruptions of late.
So China's call on ex-China markets is likely to be relatively high. The recent strength of Chinese imports has been too strong, with inventory in bonded warehouses rising rapidly, although that has partly been facilitated by destocking of refined metal from LME warehouses.
Chinese consumption is lifting now on usual seasonal demand, with the draw in SHFE stocks at the start of April of ~20kt encouraging (as long as it is not earmarked for bonded warehouses to take advantage of the LME/SHFE premium). This should help stabilise prices for now.
But on the basis that the macro environment is not supportive and Chinese inventories are large, then prices seem more likely to weaken than strengthen.
