Copper, gold price relativities poised for correction

Covid-19 has driven unprecedented volatility in industrial production patterns and commodity markets. This has spurred a flight of investment to safe-haven assets such as gold, which has a stretched price relative to copper, implying copper is poised to rise further or gold is on the brink of a drop.

Industrial production contracted by 13.5pc in China in February and up to 60pc in Japan over April, according to government data. Global supply chains have been completely disrupted from mine to market and some commodity prices have fallen by 80pc, as in the case of dated Brent oil over April to a nadir of $14/bl fob.

Over the same period, 10-year treasury yields on the Chicago Board of Exchange have fallen to 0.64pc from 1.83pc, indicating investors expect US interest rates to remain low. With prolonged fears across global commodity markets, gold prices have jumped by more than 20pc to reach above $2,000/oz on the London Bullion Market in early-August, although prices have retreated slightly in recent days, standing at $1,936/oz today.

Price ratios against gold are distorted

Three-month copper prices on the London Metals Exchange rose to $6,525/t yesterday, up by 6pc since the start of the year and 15pc year on year.

Nickel prices have recently surged to $14,880/t, up by 6pc since the beginning of the year but down by 6pc year on year. These price movements are driven by supply-side issues rather than demand as disruptions at mines and smelters steer the base metals industry in Chile, Peru and Indonesia.

But price ratios for base metals against gold further underscore the continuation of a "risk off" environment as opposed to "risk on". In the past 11 years, the copper:gold ratio — calculated as the price of the former divided by the latter — typically stood at around 5.0 but is now at around 3.4 (see chart), suggesting gold prices are high and copper is lower than in recent history. The same applies to nickel, where the long-term average compared with gold is 11.5, but the current ratio is 7.6. This is partly because of cost deflation across the base metals production base as worldwide output has increased, but the recent gold price rally has undoubtedly played a major role.

Copper prices more driven by supply

These trends suggest headwinds remain for copper prices, which are climbing despite negative trading signals. Prices are now above the 90th percentile of production costs, at around $5,800/t, and indicate there is a shortage of refined copper.

The shortage of mined material is owing to disruptions at Peruvian mines. Production fell by 20pc year on year in January-June to around 130,000t. Trade data from June indicate that a recovery is underway, and that production was back to 180,000t that month.

Chilean copper production has been less affected with mining firm Codelco increasing output by 2.5pc year on year in June to around 132,000t. But the company's mining complex did contract slightly on the year in June, with 466,000t of production.

Traders have lately been scrutinising spot treatment and refining charges (TC/RCs) that are understood to have fallen steadily to around $51/t and 5.10¢/lb from $110/t and 11¢/lb in 2015. Cathode production in China fell by 4.3pc year on year to 675,400t in July as these low levels of TC/RCs squeeze smelter margins and consumer demand remains in recovery mode, data from distributor Mymetal indicate.

But copper prices seem to have more upside risk as worldwide demand returns, suggesting that their price spread compared with gold may be set to narrow.

It remains to be seen whether global supply and prices will be significantly affected by disruptions at Indonesia's Grasberg copper mine, with the threat that protests about labour conditions will be extended for three days. The 2mn t/yr mine is transitioning from open pit operations to underground, and is only expected to sell around 350,000t in 2020 because of this transition. It is estimated that the current disruptions affect its copper sales potential by around 950 t/d.

By Maximilian Court

Gold outperforms key base metals price.pdf

Price ratios against gold are distorted.pdf

Industrial production still in recovery mode.pdf

Copper prices more driven by supply-side.pdf