By MoneyMorning.com.au
Yesterday we signed off with:
“Our bet is the Chinese economic collapse will happen soon – perhaps very soon. And make no mistake, when it happens it will cause more damage to the world economy than anything the collapse of a few dodgy European banks could ever do.
“So, what are the clues?
“For that you’ll have to wait until tomorrow. We’ll fill you in on the details then…”
Your wait is over. Here’s your first clue…
Copper.
Copper is one of the most economically sensitive of all industrial metals. When the economic outlook is good, the copper price goes up. When it’s not so good, the copper price falls.
And right now, the falling copper price tells us – and most investors – the outlook is bad. Just this morning, the Australian newspaper reports:
“Copper settled at a 15-month low on escalating concerns about Europe’s debt… Copper for December delivery, the most actively traded contract, settled down US20.05 cents, or 6.2 per cent, at $US3.0575 a pound on the Comex division of the New York Mercantile Exchange.”
Over the past six months, the copper price has dropped 28%, as the chart below shows:
Most blame the falling copper price on economic uncertainty out of the U.S. and Europe. But that’s only half the story.
What if there’s more to it than that?
We’ve looked at the latest quarterly copper production figures from Rio Tinto [ASX: BHP] and BHP Billiton [ASX: BHP]. Both companies reported a big drop in copper production.
Not surprisingly, neither talks about slowing demand. They pin the blame on a workers’ strike at Escondida (the world’s biggest copper mine) during July and August this year. And lower ore grades and mine maintenance. But we don’t buy it.
Because if the demand was strong, surely the copper price would soar as a result of the Escondida strike.
But no, the copper price continued to fall.
Not only that, there’s another clue. If there was still a strong demand for copper you’d expect copper inventories at places like the COMEX copper warehouse to report a drawdown in stock levels to make up for lost production.
Well, there’s been no drawdown according to the following 60-day chart…
…In fact, stock levels are up about 5%. Hardly a sign that copper buyers are rushing to top up their copper stock levels, is it?
Now, you could argue that industrial users of copper are drawing down on their own inventory. And maybe they are. Because as it turns out, China has one heck of a stockpile…
According to the Financial Times:
“Chinese copper inventories stood at 1.9m tonnes at the end of 2010, more than the US consumes in a year… The estimate is significantly higher than the 1.0m-1.5m tonnes range that foreign executives have assumed in the past.”
To put that in perspective, in 2010 Chinese industry used 6.8 million tonnes of copper. So by the end of 2010, China had a stockpile of almost one-third of its annual consumption.
We don’t care what anyone says, that’s a lot of inventory.
But it shows you what happens when governments and businesses have unrealistic hopes of future demand… They over-invest.
That’s partly why we believe China is set to suffer a bust on the same scale as that suffered by the U.S. economy in 2000 (refer to yesterday’s Money Morning).
Because as the boom ends and the bust begins, human instinct takes over… even in a centrally planned economy.
Businesses will start discounting stock to attract customers so they can quickly get rid of excess stock.
Naturally this will create a rush to the bottom as businesses out-discount each other. But at some point, the price drops so much that businesses sell at a loss. That just can’t last… even for a communist economy.
So, with one-third of annual usage sitting in warehouses… and consumer demand falling… the impact clearly flows through to Aussie mining companies.
Our bet is the slowing Chinese economy is the real reason BHP and Rio have seen copper production fall. Strikes and maintenance are just cover for slowing demand. And this is where it gets really tough for the Aussie miners…
Because copper prices have soared, miners could exploit lower-grade deposits. Even though costs were higher, the higher sales price made the deposits viable.
But check out the following chart from AQM Copper Inc.:
You can see just how much ore grades have fallen since the mid-1980s. In a market with rising commodity prices it’s not so bad. But in a market with falling commodity prices, it spells bad news for producers.
Because even if costs fall, it still won’t be enough to save the marginal deposits. Producers with better ore grades and higher margins will always be able to undercut the producer that has lower ore grades and margins.
In short, commodity prices – especially copper – are giving investors a clear sign that at the very least the growth in demand for raw materials is slowing. For a period this could cause investors to believe the fabled “soft landing” has worked.
But odds are what we’re seeing now is the early stages of a potentially ruinous “hard landing” that will send the Chinese economy crashing… along with the prices of big commodity stocks like BHP, Rio and Fortescue.
Cheers.
Kris.