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Thursday, December 7, 2023

The Red-Hot Case for Copper as an Inflation Hedge

Move over gold and silver — the humble copper has emerged as a potential hedge against inflation.

Copper’s credentials come from its wide use in the global economy. In 2020, 43 percent of the copper produced was used in the building and construction sector, 21 percent in electronics, 19 percent in transportation, 10 percent in consumer goods and 7 percent in industrial machinery.

Every single major sector of the economy uses copper, and because of that, its fate is tied closely to general economic growth, to the extent that it can be used as a bellwether for investment purposes. If the price of copper is rising, that means demand for copper is rising and the economy is growing. If it’s beginning to fall, demand is falling and the production of goods and services is being scaled back.

Copper and inflation: Inflation nation

But this isn’t copper’s only superpower. Because of how copper is tied into the world economy, it provides an excellent hedge against inflation. This happens for two reasons. Firstly, copper prices tend to rise before general consumer prices rise, and so can be bought as a proactive inflation hedge.

Secondly, since copper is used in many products, its price increases can be passed down into the final consumer product, which will then undergo inflationary pressures. As copper is used across the economy, these pressures can be felt in every sector, once again leading to consumer price rises.

A Bloomberg analysis completed in 2017 shows that for every 1 percent rise in the Consumer Price Index from 1992, copper prices rose an equivalent 18 percent. The red metal outperformed all other major asset classes (excluding energy) and rose twice as much as gold.

Another benefit of using copper as an inflation hedge is that it’s much cheaper than both gold and silver, allowing retail investors to use it without burning too much of a hole in their pockets.

For a number of ways to invest in the metal for retail investors, check out number six on this guide.

Copper and inflation: The risks

However, with the benefits of being so tied to economic growth come the risks as well. In times of a downturn in economic growth, copper will also be the first to be affected. In the beginning of March 2020, as lockdowns all over the world started to be initiated, copper prices fell rapidly, just managing to stay above US$2 per pound, its lowest since 2016. During the 2008 recession, copper prices dropped to US$1.30.

This is compounded in the larger cyclical nature of the economy, and thus copper. The red metal experiences deep waves and troughs as it mirrors general economic growth or contraction.

Additionally, copper is not quite seen as the store of wealth that gold and silver are. There is no historical precedence of being valued for itself and it is often used as a substitute in inexpensive jewelry. It’s not considered a “safe” investment, and its volatility with regards to price movement can explain why investors would rather a stable investment, like gold, as a hedge.

Another key risk is how world copper consumption is heavily tilted towards China. In 2020, China consumed more than half of the copper produced in the world. Europe, Asia and the Americas made up most of the other half. Any big changes in the Chinese economy will change the demand — and price — of copper. In 2016, copper prices fell to a six-year low as the Chinese economy underwent a slowdown.

Copper and inflation: The green economy

Despite copper’s cyclical risks, there’s a growing argument being made for a more secular demand. That argument rests on the advent of the green economy. Copper is one of the fundamental cornerstones of switching to net-zero emission commodities because of its excellent conductivity.

As countries around the world pursue electrification and other forms of renewable energy, copper demand is going to increase. The Copper Alliance, based in the U.K., estimates that copper demand will grow by 50 percent by 2050.

Calamos research found that renewable energy generation is five times more copper-intensive than a conventional power grid. Wind turbines, for example, are a huge copper sink: one onshore wind turbine uses as much as four tonnes of copper. For offshore turbines, this could increase to up to 15 tonnes of copper per megawatt of installed capacity.

And then there’s electric vehicles, which requires four times more copper than an internal combustion engine. Additionally, these vehicles need places to charge, and each EV charging station requires 10 kilograms of copper.

On the other side of the coin, copper production has been stable for the last 15 years, growing by less than 1 percent every year, and new copper mines take years to develop, according to Nick Niziolek, co-chief investment officer and head of international and global strategies at Calamos Investments, who told Barrons, “We think copper is a great commodity because its supply hasn’t been developed in a significant way in the last 15 years.”

Stable — and in some cases, constrained — supply, plus a growing demand, makes for an appealing investment idea. But coming to back its uses as another option in the arsenal of managing inflation: copper has gone from US$5,000 per tonne in April 2020 to US$10,000 in May 2021, doubling in value. In the same period, US inflation came in at 5 percent.

If inflation is expected to continue, one can expect the copper comeback is here to stay.

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Securities Disclosure: I, Pallavi Rao, hold no direct investment interest in any company mentioned in this article.

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