Where are we going to get the needed copper?

Copper has hit new highs as investors focus on rising demand from the tech sector, yet a fundamental supply problem remains. Not enough new fields are being discovered and developed to meet demand. 

There is talk about commodity cycles, yet understanding long-term demand requires looking at how supply is created. Mining is expensive. It requires capital investment, but this only happens after a discovery, and discoveries have different qualities of ore. If prices are low for an extended time, then there is no development, which creates a shortage. The shortage then leads to higher prices, which, if sustained,,, create the incentive to develop new mines. This is the basis for a commodity cycle. 

 

The gold real rate change in sensitivity

There are supposed to be certain “rules” between market drivers and gold. Gold is supposed to hedge inflation. This relationship has proven mixed. A second relationship is linked to real rates. Since gold does not earn a return, investors should prefer an asset with a positive real return over gold. The longer-term relationship is negative, yet the last four years show a relationship in transition. Right now, there is a a much stronger link with real rates. 

Gold can be viewed as a meme asset that reflects investors’ fears. There may be an economic relationship, but the link is often unstable.

Who is the marginal. bond buyer?

 

To price assets, you ned to know who will be the marginal buyer who will clear the market. How sensitive is the buyer to value or economic shocks? For the longest period in the US, the Fed was the marginal buyer through QE. QT was tried, but there always seems to be a hesitancy that selling would stop or slow down if rates rose too quickly. Now, the world has changed. The marginal buyers are private investors. Those private investors may either be domestic or foreign. Again, the issue is whether the marginal buyer needs to hold safe assets regardless of valuation or whether these buyers focus on valuation. I place less emphasis on Treasury arbitrage and basis traders, which is a different problem. If the perception is that bonds are expensive, or, more importantly, that rates are trending higher, yields will clearly be higher. 

Nominal yield will fall only if inflation expectations fall, term premiums fall because risk is perceived as lower, and real rates move lower because growth slows. Pension funds and insurance accounts will drive the US bond market. These buyers do not have to be vigilantes; they can just price-sensitive investors.

The diesel fuel shock - the driver of concern

The real energy shock is not with the price of crude but with the price of refined products. There is no question that crude oil prices have spiked and remained elevated since the beginning of the Iran War, but higher crude is just one component of a more complex energy price shock. Ukraine's war strategy to destroy Russian refining capacity is affecting refined product prices worldwide. Houthi attacks on Saudi refining are also disrupting the production of refined products. Finally, refining utilization is running above 96% in the US. There is no room for more production. 

So we have the following set of problems:

1. Refined product cannot move out of the Middle East 

2. Refinery capacity destroyed in Russia (approximately 40%)

3. Refining capacity impacted in Saudi Arabia

4. US refining is running above 96%, with refined product exports to Europe. 

The problem is not with crude but with refined product prices.