Finance & economics | The copper market

Red scare

Ebbing Chinese demand for copper explains much of this week’s turbulence in mining stocks

ALONG the muddy banks of the River Severn in Newport, Wales, sits the “mega-shredder”, an industrial monster owned by one of the world’s biggest metal-recycling firms, Sims Metal Management. It is one of the planet’s biggest consumers of metals—literally. Every hour the 560-tonne machine gobbles up more than half its weight in cars, washing machines and other appliances, making the earth shudder as it grinds them to pieces. It then uses magnets to separate the ferrous from the non-ferrous bits, spitting out small nuggets of steel, copper and other scrap. These are shipped to smelters in Asia, where they are mixed with ore and re-blasted into the rods and sheets that feed that other great devourer of metals, China.

A decade ago, when the machine was installed, China’s hunger for scrap seemed insatiable. Plumbers the world over developed a nifty side business as copper merchants. Theft was so rife that Britain banned cash payments for scrap metal. But in the first half of 2015 exports to China were half the level of 2012, when demand was at its peak, says Ian Hetherington of the British Metals Recycling Association. Scrap dealers’ hunt for customers is getting desperate. “I have people from small and midsized companies who spend half their lives going round the copper smelters in dim and distant parts of China,” he says.

It is not just scrap dealers who are suffering from slowing demand for metals in China. On September 28th shares of Glencore, a debt-laden Anglo-Swiss miner and trader, fell by almost a third, despite the firm’s attempt to buttress its balance-sheet in recent weeks by raising $2.5 billion of equity and suspending the dividend. Shares of Anglo-American, a London-based mining firm, also took a beating. Even after a subsequent rebound, Glencore’s shares have fallen to a sixth of their level at its listing in 2011. There is even talk of taking the firm private again—although financing such a step would be tricky.

The trigger for the latest plunge was a note from Investec, an investment firm, speculating that if weak prices persist, Glencore’s and Anglo’s earnings would be consumed by debt repayments and servicing, eventually wiping out the value of their share capital. It noted that the biggest global miners, Rio Tinto and BHP Billiton, though less indebted, were also likely to see rising debt ratios if prices remained low, which might threaten their ability to maintain dividends, much like at Glencore. It said the mining industry had “gorged” on cheap debt during the China-led metals boom of recent years. Now it is paying the price.

The commodity that accounts for the biggest share of Glencore’s revenue is copper. Like most industrial metals, its price has fallen steadily in recent years, with a predictable effect on Glencore’s shares (see chart). The sharp slowdown in industrial activity in China is disastrous for copper producers, since China consumes 45% of their output. Its attempt to shift from an investment-led economy to a consumer-led one has raised fears of a structural decline in the amount of copper it will need. However much electrical wiring there is in consumer goods, it does not match the vast tonnages consumed during the recent decades of rapid urbanisation in the form of power lines, telecoms cables and the wiring of big apartment complexes.

Estimates of short-term Chinese copper demand vary. Deutsche Bank reckons it will grow by 3% a year on average over the next five years, down from 7.5% over the past five. Goldman Sachs, another bank, takes a particularly bearish view, saying Chinese copper consumption will not grow at all this year and next.

One recent disappointment has been the roll-out of electricity infrastructure in inland Chinese cities, where investment was expected to surge this year. Analysts at BHP say such infrastructure accounts for the biggest share of copper consumption in China, more even than the construction industry. Yet a crackdown on corruption at state-run energy companies slowed the grid-laying projects during the first half of the year, analysts say. What is more, China is increasingly using aluminium for its thick power-distribution cables, rather than copper—a cheaper option, even if aluminium is a poorer conductor.

Spending on other infrastructure is accelerating, but it is unlikely to be enough. Property construction accounts for a much bigger share of Chinese investment and, with unsold homes dotting the country, is unlikely to rebound soon. Moreover, copper is needed at the end of construction, for a building’s wires, pipes and air-conditioning systems, as well as home appliances. Housing completions have plummeted by 15% so far this year; housing starts are even weaker. Though property sales are up, the number of white goods needed to fill the newly sold units is unlikely to be enough to tighten the market.

Alongside industrial attrition, copper has been under speculative attack in China too. Chinese hedge funds, dissuaded by the government from “rumour-mongering” about stocks, have launched sporadic “bear raids” on copper as a proxy for betting against China’s economy. Kenneth Hoffman, a copper specialist at Bloomberg Intelligence, a data firm, describes the size and power of these firms as “chilling”.

Speculators’ ability to roil markets is aided by inadequate data on copper stocks in China. The murky numbers on warehousing and the strategic stockpiles of China’s State Reserve Bureau have led some, such as Mr Hoffman, to believe the data overstated the strength of copper demand in China even during the good times.

Yet the outlook for China is not all bearish. As incomes increase, the “intensity” of copper use is likely to grow. China is still well short of the average-income level at which consumption of copper peaked in Japan, for instance. Nascent industries such as wind and solar power and electric vehicles, all of which are copper-intensive, may also boost future demand.

Before then, supply must fall to balance the market. After a brief rally, copper traders shrugged off Glencore’s announcement last month that it would close mines in the Democratic Republic of Congo and Zambia, cutting supply by about 400,000 tonnes over 18 months—some 2% of the world’s annual output.

Some estimate that the industry will still churn out about 500,000 tonnes of excess copper this year. Eleni Joannides of Wood Mackenzie, a research firm, expects that by the end of the year global copper stocks will amount to 80 days of average consumption, higher than during the 2008-09 global financial crisis. That oversupply will get worse: it takes several years to build a mine, so several firms were caught out when the market turned. As a result big new increments of supply have hit the market in the past year or two, just at the wrong time. Stocks will not peak until 2017, Wood Mackenzie predicts.

Glencore is not the only global miner to respond by cutting output. Ms Joannides says mines producing a further 170,000 tonnes a year have been idled so far this year. But only the most expensive supplies are being removed from the market. Many firms, helped by falling currencies in countries like Chile and Peru, are instead slashing costs to keep production going.

The industry’s fragmentation makes it unlikely that producers will agree to rein in output. Goldman Sachs notes that iron-ore producers continue to increase output, even though four of them control 65% of the world’s production; in copper the top five producers have only a third of the market. In some cases, it is cheaper over the long run to keep mines running at a loss for a while, to maintain security and retain staff, rather than to close them down.

Within a few years, however, many analysts expect natural constraints to put a floor under prices. The quality of ore in copper mines decreased during the boom. Water shortages make copper more expensive to extract. Mine depletion in Chile and Peru has driven companies towards new deposits laced with arsenic that require costly cleaning. And workers and environmentalists increasingly raise their voices against lousy pay and conditions.

Higher costs make it less likely copper production will increase, which should eventually help stabilise the market. Chinese demand may also be supplemented by growth in other emerging markets, such as India, which consumes just 2% of the world’s copper. The challenge for the big diggers like Glencore, and the “urban miners” such as the mega-shredders and scrap dealers, is to hold out until then. That is far easier to do without big debts to service.

This article appeared in the Finance & economics section of the print edition under the headline "Red scare"

Dominant and dangerous

From the October 3rd 2015 edition

Discover stories from this section and more in the list of contents

Explore the edition

Discover more

China’s banks have a bad-debt problem

As is becoming increasingly obvious

Which country will be last to escape inflation?

A new dividing line in the global fight


How the “Magnificent Seven” misleads

Forget the supergroup of stockmarket darlings