Last month, Goldman Sachs, the “standard-bearer of commodities,” released a report that attracted the attention of the industry. It predicted that oil prices would be the tipping point for the next round of commodity prices.

Since the release of the report in mid-September, oil prices have risen by more than 16%. Yesterday, US WTI crude oil rose to a high of 82 US dollars, breaking a record for more than 10 years.

The reason given by Goldman Sachs is that inventory is scarce. In the context of low inventory, tight supply may drive commodity prices to rise further.

A bullish commodity market requires following the basic principle of supply and demand: regardless of the economic growth rate, as long as demand exceeds supply, prices will rise. At a time when commodity inventories continue to decline and demand levels continue to rise. A small increase in demand will cause prices to soar.

After the oil price “prediction” came true, Goldman Sachs also pointed out in its latest report that copper prices will become the next tipping point. The reason this time was also inventory.

“As copper inventories shrink rapidly, global copper inventories may reach their lowest level in history by the end of the year. It is expected that the copper market will experience serious supply and demand imbalances, and the copper price forecast will rise to 10,500 US dollars/ton by the end of the year.”

The rise in copper prices is already evident. Yesterday, the London Metal Exchange (LME) copper spot rose to a high level. In addition, Codelco, the world's number one copper mining company, proposed to supply copper to European customers at a price of 128 US dollars compared to futures premium/liter in 2022, increasing the European copper premium by 31%.

Goldman Sachs believes that the rapid decline in copper inventories will cause supply shortages, increase the risk of rising copper prices, and analyze the copper market supply situation from three aspects, including the slowdown in copper mining and the impact of electricity shortages on smelting and copper scrap recycling.

A catalyst for rising copper prices — tight inventories and supply shortages

According to the Goldman Sachs report, copper is currently the most undervalued commodity, and the market pricing error was due to ignoring the important factor of inventory reduction.

Currently, copper stocks in the spot market are falling rapidly, and have been reduced by nearly 40% in the past 4 months. Global copper inventories may reach an all-time low by the end of the year. If copper prices remain low, copper stocks are expected to run out in the second quarter of 2022. At the same time as inventories are falling, in addition to the need for futures contract delivery, copper supply is further reduced, which will eventually cause copper prices to rise.

Goldman Sachs believes that the following three factors will affect the spot supply of copper.

1. The shortage of electricity has exacerbated the shortage of copper resources. One of the main concerns in the market is what impact does the shortage of electricity have on the copper market?

Goldman Sachs believes that electricity shortages affect metal smelters and other manufacturers, which in turn affects copper production, causing supply shortages. First, there is a strong positive correlation between coal supply and a sharp decline in copper stocks. According to energy consumption data, the smelting industry was far more severely impacted than the downstream manufacturing industry (energy demand fell 1% year over year since the electricity problem began). Simply put, electricity issues are reducing copper supply more than downstream demand.

There are seasonal factors in the Chinese copper market, and demand in the fourth quarter usually exceeds supply. Between 2015 and 2019, demand increased 16% month-on-month in the fourth quarter, while production capacity only increased 9%. This means that if we want to offset seasonal tightness, we need a greater degree of adjustment and contraction on the demand side, but judging from now on, this is unlikely to happen.

2. Looking at the copper recycling market, scrap copper recycling does not relieve short-term supply problems. Copper scrap recycling accounts for 20% of global refined copper production and nearly 30% of semi-finished copper consumption, and is an important influencing factor affecting the short cycle of the copper market. The supply of copper scrap grew strongly at the beginning of this year, then suddenly tightened. The supply of copper scrap continued to decline in the second half of the year, from a peak at the end of the first quarter to a year-on-year contraction of nearly 15% now.

This reflects that from the third quarter of 2020 to the early second quarter of 2021, the long-term inventory removal phase caused by price and demand factors reduced the supply chain's copper scrap inventory.

Furthermore, Malaysia's export quality regulations on copper scrap are more stringent, limiting the supply of scrap copper. These indicate that the copper scrap market has turned into the current trend of austerity. Without copper scrap stocks to replenish supply, potential supply will fall short of demand and cause prices to rise. Although the rise in copper prices will help stimulate the supply of scrap copper, the lagging effect is obvious given low inventories.

3. Copper mining has been stagnating for many quarters. Goldman Sachs pointed out that one common misunderstanding about copper fundamentals is that the supply of copper in the market is declining, and copper mining can quickly supplement the supply.

Although global copper supply is expected to increase in the first quarter of 2021, with a growth rate of 5%. However, the short-term copper shortage problem has yet to be solved. The COVID-19 outbreak in the first quarter of 2020 led to a sharp reduction in copper mining.

Since the third quarter of last year, mining volume has stabilized and peaked in December of last year. Since this year, mining volumes have continued to decline slightly. Goldman Sachs expects global mineral supply growth to slow in the second half of this year and not pick up until the second half of 2022.

This means that three-quarters of the copper market supply will stagnate with few new mine project approvals and capital expenditure increases.

Goldman Sachs vs. China Flag

Wall Street actually did not reach a consensus on the future of copper. Citi is on the bearish side. The reason for being bearish is on the demand side rather than the supply side.

It believes that the sharp rise in gas and electricity costs will make the copper market unbearable and may trigger a new round of stagflation. Demand from consumers and manufacturers falls sharply, yet the cost of commodities and raw materials remains high.

Citigroup's commodity research team warned that demand for copper will shrink in the next three months, and copper prices will drop another 10%. Max Layton, head of commodity research at Citibank, said that the main reason he is bearish is that the European electricity, oil and gas crisis spreads, and the copper market will get worse.

In Europe, IHS Markit last month saw the biggest drop since April 2020 (the start of the pandemic), an indicator measuring business activity in manufacturing. Companies such as CF Industries, Yaran International, and BASF said they will cut production due to high energy prices, and growth in new orders, output and employment will slow drastically.

Codelco Chairman Juan Benavides also said in an interview that the copper market has not seen any signs that manufacturers are reducing demand due to high energy prices. Despite this, the macroeconomic outlook is uncertain, and he believes copper prices may not reach new highs in the short term.

Of course, there are many parties that agree with Goldman Sachs's views.

Kostas Bintas, head of copper trading at Toko Trading Group, believes that aside from the rise in commodities, the global stock market is falling rapidly, and it is obvious that the copper market is facing a serious shortage problem.

Copper prices surged to more than $10,700 per ton in May as lockdown restrictions triggered increased demand for housing and consumer goods. Many traders and banks are betting that prices will rise further. They believe that with the development of manufacturing and increased demand for electric vehicles, demand for copper will also increase.

The Bank of America said that if there is a problem with the supply and demand side at the same time, the copper price may reach 20,000 US dollars/ton.

David Lilley of Drakewood Capital Management, a London metal hedge fund company, said that the tight spot market may help push copper prices to another record high, probably before the end of the year, which is roughly in line with Goldman Sachs's forecast. Lilley said in an interview,

The obvious truth is that all energy in the world is running out. Global copper stocks are shrinking, with no sign of rising.