the copper canary

Miners used to carry canaries into mines, looking to the sensitive birds for warning of carbon monoxide and other dangers.

Miners used to carry canaries into mines, looking to the sensitive birds for warning of carbon monoxide and other dangers.

Canaries were simple but effective. They were used until 1986 in Britain, when Margaret Thatcher’s efficiency experts laid them off and replaced them with electronic sensors.

Now that the global economy resembles a mining disaster, full of dark holes and smoking rubble, we too need a simple guide to danger ahead.

One yardstick is the price of copper, which gives better advice than any number of economists.

The first reason for this is that copper demand is broadly linked to economic activity. We use the metal for a startling array of purposes, from wire to copper pots to integrated circuits to oil tanker hulls. So its demand is a good indicator of global economic growth.

It’s also especially interesting in the Yukon, where copper mining is a growing part of the economy.

On the supply side, it is relatively plentiful and produced by a large number of mines around the world.

This means the supply of it tends not to be distorted by cartels, and that events at a single mine or country don’t influence the price too much.

The final reason why the price of copper is interesting is that it is traded in a global and liquid market. This means that instead of relying on one forecasting expert, however smart, the price of copper reveals the thinking of thousands of copper buyers and sellers around the world. These are miners, manufacturers and speculators. They each have millions of dollars at stake, which tends to focus the mind.

This isn’t to say that markets are always right – hardly a point we have to argue about these days – but that they tend to be a pretty good guide much of the time.

For example, consider “political prediction” markets where people buy and sell mock shares whose value is based on the vote received by a political party in an upcoming election. These markets regularly beat both pundits and opinion polls in predictive power.

So what is the copper market telling us?

As you can see from the chart, the messages are ambiguous.

On the one hand, copper is trading almost three times higher than its average price during the decade from 1994-2003.

On the other hand, copper is sharply down – more than 35 per cent – from its peak just a few months ago. There was a particularly nasty 15 per cent drop the week before Thanksgiving.

One troubling thing about the chart is the steepness of the rise in the price of copper since 2004.

This graph, unfortunately, looks rather like the share price of Nortel in 2000 or of Lehman Brothers more recently.

Which brings us to the “money” question: is there a commodity bubble and, if so, will it be the next to burst?

This could be devastating if you were, say, a small northern territory relying on some new copper mines for jobs and tax revenues.

Copper prices definitely went up because of demand from buoyant economic growth around the world, especially the massive increases in industrial production in China and India. This is a fundamental factor and China and India are likely to keep growing relatively rapidly for years to come. But if copper was worth $1,600 per tonne on the London Metal Exchange in 1991, was Asian growth really enough to justify a price of $8,700 in April of this year?

On the downside, you can see the telltale indicators of bubble behaviour.

The global liquidity expansion that inflated stock and housing markets also flooded into commodities.

Economists at Britain’s Financial Services Authority note that the face value of commodities derivatives contracts went from a paltry $1.3 trillion in 2004 to $6.4 trillion in 2006.

Other market observers estimated that $200 billion was invested in commodities in mid-2008, up from $13 billion five years ago.

A quick scan of the press releases of major banks and hedge funds shows new commodity funds being launched steadily into 2008.

So what does the copper price tell us will happen next? Let’s look at the futures prices. These seem to indicate that people are expecting copper prices to stabilize well below their peak, but also well above historical prices.

But the prices are volatile. Markets are often good predictors, but they are also notorious for panics and herd mentality.

Alan Greenspan, the former chair of the Federal Reserve, always used to ask a good question when he was reviewing forecasts: what are the consequences if you are wrong?

If the futures prices are indeed good predictors and copper prices stay between $5,000-6,000 per tonne, we are probably in good shape.

Most copper mines will be profitable and it will also mean that global economic growth is solid.

If we are wrong on the upside, and copper prices rise, that is likely modestly good news.

We will pay more for our copper products, but in the Yukon it will mean good times for the mining sector.

But if we are wrong on the downside, there would be trouble.

First, any local mines that hadn’t locked in their prices would see major revenue drops. A severe scenario has a bursting commodity bubble and a collapse in copper prices, with devastating impact on mining profits, employment and tax generation.

Even a more modest price drop could mean a global economic slowdown, filtering through to the Yukon via lower transfer payments and fewer tourists.

So futures prices suggest copper prices will stay around $5,500 per tonne. But there’s obviously significant uncertainty.

The general view of Yukoners seems to be that the economy, like copper prices, will retreat a bit from last year’s boom, but will remain generally strong.

The Yukon government, for example, cut some departmental budgets this year, but is still cutting into our rainy day cash reserve with a $22-million cash deficit driven by a wide range of spending programs.

Hopefully Premier Dennis Fentie is taking Greenspan’s advice and thinking ahead, just in case he turns out to be wrong.

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