By Mobeen Tahir, Associate Director, Research, WisdomTree.

Copper back on the charge

An opportunity hiding in plain sight

The global economy is gradually emerging from an acute shock earlier in the year. As the world’s economic engines are reignited, markets too will breathe a sigh of relief.

But some investors may take the view that the cyclical recovery has already been priced into certain assets. Take US equities as an example – the S&P 500 Index is swiftly approaching its previous all-time highs recorded in February this year.

The question that arises, therefore, is: what asset class would benefit from an economic upswing but hasn’t moved to price it in yet? We believe this is industrial metals. And to pick a candidate from within the pack, we choose copper.

Moving slowly, but moving nonetheless

Not all cyclical assets move in tandem. US equities have surged since the current switched its direction in April. This, however, was more a symptom of tech sector strength rather than improving economic fundamentals. Copper, in contrast, aligns more closely with emerging market equities. This makes sense – China accounts for around half of world copper demand and holds a weight of nearly 40% in the MSCI Emerging Markets Index. Copper’s fate, and that of emerging market equities for that matter, is therefore inextricably intertwined with China’s economic outlook.

Source: WisdomTree.

China gradually returns to normalcy

China was the first to endure the pandemic and the first to emerge from it. As strict lockdowns were lifted in April, economic activity gathered steam. Now, we completely endorse the view that 2020 will be a painful year for economic growth. Indeed, Chinese policymakers have acknowledged this too, setting aside their cherished 6% GDP growth target for this year. But manufacturing Purchasing Managers’ Indices (PMIs) for May paint a promising picture of a budding economic recovery. As the outlook for manufacturing improves, copper demand will be boosted.

Source: WisdomTree.

Chinese policy relief has arrived

At the recently concluded National People’s Congress in May, Chinese Premier Li Keqiang unveiled a RMB6.1tn ($853bn) fiscal package. This economic inducement will include an allocation to new infrastructure spend – with a focus on 5G and electric vehicle projects. Copper is integral to both. Copper’s durability, high conductivity, and efficiency make it a core component of electric vehicles, charging stations, and the entire supporting infrastructure. Similarly, the deployment of 5G technology requires both fibre and copper cable across the network. An investment in these technologies can electrify the demand for copper.

There are always risks

Copper’s demand and supply were broadly in balance in January before the pandemic accelerated. As a result, some of the demand weakness was offset by mining supply disruptions in key producers, notably Chile and Peru.

Unlike some other metals which were in a supply surplus, copper’s inventories on exchanges experienced a quicker drawdown through April and May. This also explains the quicker recovery in copper prices relative to other industrial metals so far.

As mining activity resumes, support for copper prices from tight supply will wane. Copper will thus rely on a pick-up in demand to propel the charge forward.

A second wave of the pandemic is a risk that applies to all cyclical assets. Copper is no exception. If governments are forced to tighten lockdowns yet again, economic activity will be jolted. Nevertheless, we draw comfort in not hearing any alarm bells yet.

Source: WisdomTree.

Markets are placing their bets

We believe markets are beginning to recognize the potential energy in the base metal. Net long speculative positioning in copper futures started to rise in May. If the cyclical wave of economic recovery materializes, copper will stand to benefit, and with copper being a key component of future technology – 5G and electric vehicles – we envisage a sustainable outlook for the metal’s demand.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)