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If China keeps slowing, copper’s in for a meltdown

Lex is a premium daily commentary service from the Financial Times. It helps readers make better investment decisions by highlighting key emerging risks and opportunities.

Copper was supposed to be the metal which could withstand any slowdown in China. A geological barrier to entry exacerbated by bad weather, earthquakes, permits and declining grades in old mines is a constraint on supply. Reserves in Chile, the world's biggest producer, are falling by an average 5 per cent a year. Yet the copper price has fallen by 5 per cent since China, the world's largest importer of the red metal, announced worse than expected growth for the first quarter over the weekend.

Yet any geological advantage that should support a commodity price is not helped by the wrong mining strategy. The 5 per cent expected growth in copper production this year marks the fastest supply growth in over a decade, according to Wood Mackenzie data. If the slowdown in China's economic growth continues, this is going to be a problem.

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Cash costs among the world's copper miners average around $5,000 (U.S.) a tonne. As a result, with prices around $7,100 today, profits are being squeezed versus the days when prices were over $10,000 back in 2011. The fall in the price of gold will hurt cash costs further since two-fifths of the world's copper mines gain some form of byproduct cost credit, says Bernstein. At Antofagasta, for example, credits from by-products such as gold and molybdenum helped to reduce cash-costs of mining copper by a quarter last year.

In the medium term the slowdown in China is sure to weaken real demand for copper. Especially where the large amounts stored in bonded warehouses compounds any excess supply. Unlike steel, copper intensity in China has been constrained by price and as a result will remain below that of levels in the U.S., which historically benefited from its own large domestic supplies. Rio Tinto, Freeport-McMoRan and BHP Billiton remain at the lower end of the cost curve. That is where investors should keep their focus.

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