In the 10-½ months since hitting their lows, copper prices have risen by over 70% to their highest levels since January 2013 (Figure 1). The strength in copper may come as a surprise given the pandemic’s dislocation of the world economy. Outside of China, economic output is smaller today in almost every major economy than it was at the end of 2019. Despite its rapid recovery, China’s economy grew by less than 3% in 2020, its slowest since the 1980s.
That copper prices have risen so much speaks to the uneven nature of the pandemic’s impact on the global economy. Certain sectors, such as transportation, hospitality, entertainment and oil production have borne the brunt of the economic shock. By contrast, other sectors remain relatively robust. Among the strongest are manufacturing and construction, both of which are heavy consumers of copper.
This much is apparent in the U.S. economic data. Retail sales, which include the sale of many manufactured items, excluding automobiles and gasoline, tumbled in March and April only to rebound by growing as much as 5% year on year later in 2020 (Figure 2). Likewise, housing starts and building permits also rebounded sharply and by the beginning of 2021 were at their best levels since before the global financial crisis (Figure 3).
One sees a similar pattern in China. China’s official GDP, which includes manufacturing and services, contracted sharply in Q1 2020 before recovering slowly as 2020 wore on. China’s manufacturing sector, which we measure with the Li Keqiang Index (that tracks electricity consumption, rail freight volumes and bank loans) which did not show any negative growth, rebounded to 8-9% YoY growth rates by May 2020, where they remain. This suggests that in China, too, manufacturing rebounded much more quickly than the overall economy (Figure 4).
That Chinese manufacturing rebounded quickly is emblematic of the state of the global economy. Many consumers around the world possibly accumulated substantial savings since they were unable to travel, eat out or attend outdoor events. However, their demand for manufactured goods remains strong. Also, sharply lower interest rates around the world have spurred a boom in the construction industry, especially in residential real estate outside of major cities like London, New York and San Francisco.
Each year China consumes 40-50% of copper ore, which is refined and turned into semi-finished and finished products, many of which are re-exported. As such, it’s not surprising that copper prices show a strong, positive correlation to the state of the Chinese economy. In particular, they show a strong relationship with the Li Keqiang Index, a proxy for the strength of the Chinese manufacturing sector (Figure 5). The correlation of copper prices with the year-over-year change in the Li Keqiang Index is much stronger than the correlation between copper and China’s official GDP. Over the past 15 years, copper prices have sometimes shown a correlation of as high as +0.55 with the Li Keqiang Index and the correlation peaking a year after the change in the pace of China’s industrial growth rates is observed (Figure 6).
Demand has not been the only factor driving up prices. While the pandemic did little to interrupt demand for copper via manufactured goods and housing, it did disrupt mining supply. Many mines in Chile, which accounts for 28% of global copper supply, closed for at least part of 2020 as a result of COVID-19. This led to a 3.7% dip in copper production globally during the second quarter of 2020. For the year, copper production fell by approximately 1.5% from 2019. Just as demand for copper-intensive manufactured goods and housing was picking up, copper supply was contracting.
Over the longer term, copper has been a major outperformer among industrial metals. Its price has risen much more than aluminium and, until recently, iron ore or hot rolled coil steel (Figure 7). This is probably partly due to the much slower growth of copper supply over the past quarter century. Since 1994, copper mining supply has doubled while the supplies of other metals have tripled (Figure 8). As such, copper supplies were relatively tight compared to those of aluminium and iron ore going into the pandemic, although prices of those other metals have also risen sharply in recent months as they too have been driven higher by the combination of mine shutdowns and strong consumer demand.
At-the-money (ATM) copper options have been trading near 25% implied volatility for much of the past nine months. This is not extreme by historical standards and are far below peak levels during the global financial crisis or even during the sharp selloff in copper in February and March last year. That said, implied volatility on ATM copper options is much higher than it was, on average, over the three years prior to the pandemic, when it averaged around 17%. This suggests that traders see somewhat elevated risks now than they did in the three years preceding the pandemic (Figure 9).
ATM implied volatility is only part of the story, however. The so-called “risk reversal,” which measures the skewness of out-of-the-money (OTM) copper options, shows that traders have a relatively neutral view of extreme upside versus extreme downside risk (Figure 10). At the lows in March 2020, OTM put options were exceptionally expensive relative to calls. Since June, OTM calls and puts have been trading at fairly similar prices. This suggests that, for the moment, traders see extreme upside and extreme downside risks as being relatively balanced.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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