Will Base Metal Demand Fall Off a Cliff?
A year ago I was highly uncertain about where I thought base metal demand might go. As an investor I examined both the bull and the bear arguments.
As technology improves costs generally decline and there has been an overall downward trend in base metal price over the past century and probably longer if one was to research it. In recent years the evidence suggests that the cost for mining base metals has gone up and the ability for prices to further decline through technology gains or cheaper labour no longer exceeds the rate of cost increases. There do seem to be price supports based on costs.
However, metals can end up being sold for a loss should supply end up ahead of demand. World demand has been increasing and in the past few years the increase in supply has not kept up with the increase in demand, resulting in an enormous boom in base metals at unsustainable high prices.
But how and where did all that demand come from? The bulls suggest that we are at the beginning of a boom in a long term cycle for base metals due to the emerging economies. The bears suggest that over investment will result in massive supply that will slaughter metal prices. The question doesn't have an easy answer, nor is it one that I can accurately answer, but I can look at where some of the demand came from and consider it in my investment decisions.
The US has had a housing boom. Last April housing starts were 2.1 million. At about 400 pounds of copper per home, that's an enormous source of demand for copper. Indeed, spending some time searching the internet I found that home construction accounts for about 40% of US demand for copper. It seems to me that homes that were only starting to be built last April would have been using copper that has been sold in recent months. Fast forward to now and housing starts in the US have declined to about 700,000, roughly 1/3rd.
A simple extrapolation suggests that the US demand for copper could decline by 25% in the coming months from the decline in housing alone. With US consumption around 15% of world supply, well that would result in almost a 4% decline in world copper consumption from the US alone.
This very simple look at copper got my attention. The enormity of the decline in the US housing starts will not easily be off set by increases elsewhere, if there are indeed increases elsewhere. I did a search on housing starts in other countries. In Japan housing starts fell 35% in October from a year earlier.
India is supposed to be an emerging economy and one of the places that demand for metals is supposed to be increasing, at least that's the impression I get with all the hype. Imagine my surprise when I wasn't even doing research on India, but steel, and an article about the stock piling of steel rods due to a slump in apartment construction came up. Copper goes into apartments as well.
Australia seems flat, which is better than down.
I also looked at news about copper demand and I found an article about projections of copper usage. The article has nothing in it to satisfy me that the projections are reasonable. It points out that demand from China drove the growth in 2007, but go back a year to 2006 and that was when copper peaked at over $4/lb and China was not replenishing its warehouse stores of copper. After the price of copper dropped in early 2007 China was a buyer so it is no surprise that the market was in a deficit in the first 8 months of this year. I have seen no evidence that China has grossly diminished storage levels of copper now. It seems to me that replenishing storage levels would have resulted in more demand for copper in 2007 then what is actually being used, which isn't good for outlook for demand for 2008.
If I look further at industry growth, the news suggest the mining industry is going full steam in their efforts to increase supply.
Copper demand seems highly dependent on home construction and the evidence that I see is that the level of housing starts are declining beyond what most people would have guessed, and this has enormous negative implications for copper. Supply is still being ramped up and demand is falling, and it seems probable to me that supply will exceed demand, and by more than what many people expect. I personally will sit out and watch copper rather than be vested in it.
I remain uncertain about where I think demand with other metals will go. They are not as dependent on housing. Pipelines, for example, do need replacing. There was one that failed just this past week in Eastern Canada. But the question is will the money be there to replace pipelines? With the high level of uncertainty and the nature of price leverage due to supply, for me it is time to exercise caution for investments and watch the market rather than participate.