All questions I have pondered. Let's just take copper, because that's the most obvious and the one I'm playing actively.
Backdrop: We have about 14 million MT consumed a year right now. We saw a 0.2% drop in production (let's just call it flat) in the 2nd quarter despite a $1.25 price. If we used Comex, LME and Shanghai inventories for draw down we can closely construct the supply-demand set-up for this market. Since production (supply) is flat we could probably give consideration to utilizing this to diagnose the global economy, they don't call it Dr. Copper for nothing. Maybe a little simplistic, but I think a good exercise. From my daily index card.
May: inventory drawdown was about 78,000 MT: copper deficit is 936,000 annualized, or 6.7% of global demand.
June: inventory drawdown was 72,000 MT; deficit 72,000, 864,000, 6.2% of global demand. Could it be argued that the world economy contracted 0.5% from May to June? I think so.
July: drawdown is 55,000 MT, deficit is 660,000 annualized, 4.7% of global demand.
August: 8 days showing about the same drawdown rate as July.
Did the world economy contract 1.5% in July? That may be overstating it, but I'd still guess July was quite a contraction. Probably July saw the arrival of disrupted Grasberg supply, so that accounts for about half the down shift. I'd say 0.8% is my July-August SWAG. So I'll SWAG global GDP having contracted by 1 1/4% annualized from May to August.
Sure that might give the market "pause", but now let's examine what's required to prevent the remaining 180,000 MT in LME, Comex, and Shanghai inventory from going to goose eggs. The July-August "economic contraction" draw rate is currently about 2600 a day, or 650,000 MT annualized. That's a bit over three months to get to zero. So if the world GDP contracted another 1% immediately, you would get about a 500,000 MT deficit. In otherwords to get the copper market back into equilibrium Dr. Copper (the economy) would have to contract by over 4% (a depression by any measure) from August.
Could that be about to happen? Possibly, but I think you will see price rationing of the last 180,000 MT of inventory first. At any rate your first clue will be in the drawdown rate (spread out over a month or so). Remember there is no meaningful new supply, so if drawdown suddenly dropped to 35,000 a month, that might suggest a another serious economic deceleration was underway, 1.7% by my math.
But let's just take a worse case, we are in mid-Sept, and the draw down has slowed to a 420,000 MT annualized deficit (1750 MT a day), and the global GDP is in deep retreat. We are now down to about 135,000 MT left in inventory. That's nearly four months to zero, a little better calendar wise, but worse in relative numbers. If you are a copper consumer (say China), aren't you going to be getting damn nervous, weak economy or not? And how about those hedge funds, wouldn't they be tempted to start a run, weak economy or not?
Then just carry out this exercise on through. Conclusion: a severe depression (6% drop from last spring) will bring the copper market back into equilibrium at extremely low inventory levels. I think there will be a depression from this, but caused by price spikes from severe shortages, probably in both energy and metals, and in time even food (a subsistence item). New supply you say? That's several years away, and I don't see anybody whatsoever in a hurry to deal with that solution, do you? HUGO trades at 3.88 today, NTO at 1.96. They have two of the best undeveloped deposits in the world, and nobody seems lined up for them, at least today. |
