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The Commodity Super Cycle?

By Victor Goncalves      Printer Friendly Version
Mar 11 2008 3:12PM

www.enereport.com

So what’s driving it? I would like to take a second to show some interesting statistics.

On June 30th 2001, copper was near or at its all time low of around 70 cents, effectively uneconomic, and had been like that for some time. Inventories were also at all-time highs. That date also reflects the highest price-point of the US dollar. Since then, we have seen the largest run in the price of copper (as well as all commodities) ever. 

There are several key drivers to this that have to be examined. We’ll look at copper and then extend it to other commodities. The sheer increase in consumption without much production has caused the inventories levels to drop about 78%. Based on that alone, and assuming a perfectly competitive market, we should have seen a proportionate increase in the price of copper. After doing the math, we should get a price of copper based on inventories of 2.47 a pound, a far cry from the current 3.90 a pound. Or another way of looking at it is to take the current price of 3.90 and adjusting it down by 37.6 percent to reflect the weakness the US dollar has had since 2001 and it comes out to 2.43 a pound. Either way it comes to roughly the same price and they reflect equilibrium between price and inventories. This is very interesting because the price of copper is not determined by fundamentals alone, when reflected in US dollars as just demonstrated.

So how do we price copper as well as all commodities?  If we use the fastest growing economies, then it is either the Chinese currency or a basket of the Asian currencies. That is problematic because of the manipulation of the currency and the weakness of the banking system in most Asian economies. The next candidate is the EURO. If we price copper in Euros, we get a price of 2.57 a pound. What we have is a (nearly) perfectly competitive market in copper, based on the fact that copper inventories have decreased by the same proportion of the increase in price (using Euros). The price of copper is (nearly) perfectly reflected in Euros. This suggests that the Euro is a much stronger and safer currency. Again to emphasize, this relationship is between the price of copper based on the inventory numbers and the price of copper priced in Euros. One other quick note in the name of consistency, the price of copper (as well as all other commodities) was roughly the same in Euros as in USD in June of 2001.

Going back to fundamentals, we have not seen a noticeable change in the inventories of copper since about early 2005. That suggests that the price move of copper was strictly correlated with the change in the US dollar. Sure there were small fluctuations in the inventory numbers, but that was reflected in price as well.

So what is going to drive the price of copper going forward? If the US dollar falls even farther, which I think it will, then we will see an increase in the price of copper. Inventories seem to be holding steady in a range, so I personally will be using the EURO dollar to price copper.

How do the rest of the commodities stack up under the same analysis? This analysis works surprisingly well for all other metals, as it is based on simple supply and demand principles adjusted for inflation. Here is a table of the results;

 

 

 

 

 

 

change in

price based

 

 

 

Jun-01

Mar-08

Mar-08

difference

inventories

based on

 

 

 

USD/EURO

USD

USD adjusted

EURO

US-EU (%)

from 6/01 to 3/08

inventories

% difference

 

CU

0.7

3.9

2.43

2.57

5.4474708

-78%

2.47

3.8910506

e

moly

5

32

19.7

20.8

5.2884615

-67%

15

27.884615

o

zinc

0.35

1.3

0.78

0.78

0

-82%

1.57

-55.6414

u

lead

0.2

1.39

0.89

0.99

10.10101

-80%

1

-1.010101

e

Ni*

3.5

14.85

9.5

10

5

-60%

8.75

12.5

o

AL

0.62

1.43

0.9

0.95

5.2631579

-60%

1.04

-9.473684

e

 

 

 

 

avg

5.1833501

 

 

 

 

 

* the inventory levels of Nickel have been exceptionally volatile over said period of time, thus an average is taken

 

e = equilibrium

u = underpriced

o = overpriced

What I would like to point out is the following:

  1. With the exception of moly and zinc, all metals prices are within 10 percent of their equilibrium, which for anything that is tradable on a daily basis is remarkably good.

  2. The price of Moly and zinc in Euros should therefore adjust accordingly to their inventory-reflected prices.

  3. Pricing of commodities in Euros is only on average 5.2% different than the US currency inflation adjusted price.

  4. About 1/3 of the commodities rally is due strictly to the drop in the US dollar.

Going forward, the question begs to be asked what will happen to commodity prices? The answer to this is relatively simple. For the foreseeable future they should remain fairly close to or at these levels in Euros. The US price of the metals will fluctuate with the change in the US dollar. I am of the camp that the US dollar is on the way out. So in US terms I believe that the price will continue to rise until we start pricing commodities in Euros.

As for inventories, they hit their lowest point in 2005 and have been stable or slowly rising ever since. This means that there is enough copper feeding the markets to keep up with the current consumption rate. This is reflected in the record amounts of exploration. This will not translate into any meaningful increase in production for several years yet, but it does suggest that the clock is ticking towards lower metals prices, or at least that we may have had a peak in metals prices in real terms.

Victor Goncalves

 

****

All pricing information was taken from www.kitco.com, the LME, www.infomine.com. Moly inventories have been taken from a research piece form Sprott Asset Management.