The Curious Case of Copper and Gold Prices
As prices rise in parallel, what should producers be doing to best position their businesses?
Historically, copper and gold prices have been driven by very different underlying sources of demand, as so, when the price of one rises, typically the other falls. And there are well known dynamics driving this relationship. Copper, often referred to as a global economic bellwether or ‘canary in the coal mine’ for global GDP, sees its demand driven by industrial activity and thus is closely linked to economic development. Gold, meanwhile, has historically been an investment of choice for those seeking a safe haven in times of uncertainty and turmoil. It has also been used as a hedge against future inflation and exhibits many characteristics of a quasi-currency.
So, in today’s unusual world, while we might have expected to see a rise in gold prices, that’s not entirely the case. Since around the end of March 2020, following the Covid-19 driven trough in global markets, a curious dynamic has developed between the two metals. Rather than following their customary divergent paths, the metals’ prices are moving higher, together.
In August, Gold reached a high of USD 2,035 an ounce, up from this year’s low of USD 1,490 per ounce in March, and topping a previous record of USD 1,921 per ounce in 2011. Copper meanwhile topped USD 6,833 a tonne in September, up from this year’s low of USD 4,774 in March and reaching a two-year high.
What’s Driving this Phenomenon?
If we look past prices and to the fundamentals, we can see this being driven by specific factors for each metal, with different implications for what producers should be doing to best position themselves for the coming 12 to 24 months.
Copper was initially impacted by the spread of Covid-19 across China, a country which accounts for almost half of the metal’s global consumption. However, thanks to the subsequent recovery on the back of economic stimulus, and manufacturing activity in the country growing at its fastest pace in almost a decade, demand has been spurred on once again.
If we consider this alongside the fact that there have been Covid-19 related supply disruptions in the short-term, particularly in two of the world’s biggest producing countries, Peru and Chile, and the decline in the volume of copper stored in warehouses, we get a better picture of the factors that have supported copper prices.
Gold on the other hand has been moving higher for entirely different reasons. In general, the prospect of a prolonged economic downturn has driven investors to seek security, and Central Banks continue to keep rates low and stimulate economic recovery with loose monetary policy. Similarly, the weakening USD has also led to investors buying gold rather than other currencies. Combined, these elements have led to record inflows into gold exchange traded funds (ETFs). As at the end of September 2020, gold ETF holdings had increased by circa 67% year-on-year, illustrating many investors’ desire to find a position of safety and a hedge against these inflationary pressures.
In summary thus, the dynamic in Copper is driven by shorter term issues while the drivers of gold have much longer time horizons to unwind once set.
While this dynamic persists, what should those in the sector be looking to do?
For those in copper, commodity price hedging over the next 24 months is an effective way to lock-in historically attractive level of copper prices today. There are various ways to do this with zero cost collars, allowing some price participation in both directions to buying puts, establishing a floor under prices and full up-side participation.
For those in gold, it is the ideal time for portfolio optimization through disciplined M&A, with a focus on lowering the cost of production. The divestment of more marginal, higher cost operations has never been more attractive. The opportunity to acquire lower cost operations, while difficult, is also worth the effort. Targets may not be cheap, but in the long run, it will pay dividends to invest in these strong, resilient operations today.
What does the future hold?
Given the factors outlined above, there is no expectation that copper and gold prices will continue to move in tandem (either up or down).
As for copper, it is clear that global economic growth – the traditional driver of copper prices – is facing significant headwinds in the medium term. Further outbreaks of the virus in various markets could impact demand and sentiment. And so, faced with resurgences of Covid-19, it’s not easy to predict how long the metal will continue to see support lifting or even maintaining current price levels.
Meanwhile for gold, the forward curve is trading at levels above current spot prices out to 2023. At the same time and over that same time horizon, the consensus analyst forecasts project prices to decline from today’s spot. This is creating a circa USD 250/oz gap in 2023 between the analyst projected gold price to where the price could be locked-in via hedging at the forward curve*. Thus, an arbitrage opportunity exists today to lock-in higher future prices at the level of the forward curve.
It’s unclear how long this dynamic will persist, but while it does, it can be used in multiple ways from potentially pushing up consensus equity valuations with hedging to supporting more ambitious leveraged acquisitions.
*Source: Bloomberg as at 13-Oct-20