“COPPER’S ROLE IN THE MONEY GAME” BY SIMON HUNT CEO SIMON HUNT STRATEGIC SERVICES AT THE CLSA ASIA CONFERENCE SAN FRANCISCO 2 ND MARCH, 2010 S Good morning Ladies and Gentlemen. First, I would like to thank CLSA for inviting me to speak at this prestigious conference; and secondly to say straight away that I absolve CLSA from everything I say. The thoughts, ideas and forecasts are mine and mine alone. And thus the responsibility for being wrong should be laid at my door – not, of course, do I think that the direction of my thinking will be anything but correct! Adventuring into the future is a perilous exercise. Models which extrapolate from the past into the future are normally useless, because the future is invariably defined by developments outside the realm of regular expectations, or, by Nassim Talib’s Black Swan events. In fact, a friend recently lunched with him and asked “You might wait a long time for the next Black Swan ” to which his reply was, “You might. You might not. No one can know. But we live in volatile times. ” Slide 1: “Unless you expect the unexpected you will never find truth, for it is hard to discover and hard to attain.” Heraclitus, the pre-Socratic “Weeping Philosopher” of Ionia S But we have to venture onto this journey despite knowing that the future will be different from yesterday or today. In fact, “Unless you expect the unexpected you will never find truth, for it is hard to discover and hard to attain”. The history of successful thinkers about 1
the future dates back before Christ so we should rely more on assessing exogenous events than the power of computer simulations. Slide 2: Speech Title should have read: “What Drives Copper Prices? Real Fundamentals or The Money Game” S Perhaps, too, the title of my speech is too simplified and should have read “What Drives Copper Prices? Real Fundamentals or The Money Game”. For, most commodities have just become another unit in the business of securitisation for banks to sell onto their pension fund and other retail clients, using sophisticated simulations of the past. The question, of course, is “Will the past give us an accurate direction of prices for the future”. I doubt that the recent past will do so for markets are in a period of transiting from years of secular high economic growth, to a large extent based on leverage and debt, to one of secular lower, but sustainable, growth. The transition will be marked by volatility with the risk of the next Black Swan appearing, as hinted at by Nassim. Copper is an integral part of this business. The user industry has little response because the collective resources of the financial sector are infinitely greater than those using the metal as part of their daily business. Their response is not financial and, not necessarily short- term, but industrial, by designing copper either out of their products or limiting its use. This is why I make no apology for focusing so much of this talk on the outlook for the global economy and the direction of financial markets. Slide 3 : Presentation Divided into • Macro-Overview • Fundamentals of the Copper Industry • Pricing 2
I will divide this presentation into three main parts. First, an overview of the global economy out to 2015; second an analysis of how we see the fundamentals of the copper industry; and third a look at some of the structural changes in how copper is being priced, together with our forecasts for their direction. Slide 4: “Business Cycles End in Recessions; Credit Crises in Depression” Michael White, Global Strategist S Market noise often detracts from an ability to understand the large picture which is unfolding; and it is this big picture which will determine the profile of global economic activity for the coming decade. Consider some simple historic facts. The 1960s were the decade of the Nifty 50s; the 1970s their demise. The 1980s the decade of Japan and the Asian Tigers; the 1990s their collapse. The 2000s was the decade of China; and this decade? Guess what in my view? China will founder and its foundering will be one of the great shocks of the coming decade, as financial and commodity markets look upon China as their bee-all to end-all. And of course the 1930s were the exact opposite of the 1920s. The bullish events of these prior decades all fell on the sword of outliers. Slide 5: A Stair-Step Decline 3
As a simple person, I find it incongruous that the world can evolve from teetering on the cliff’s edge to transiting into recovery and sustainable growth in just a year. Massive fiscal and monetary stimulus provided the band-aids, but they have done little or nothing to cure the wounds. I keep this graph on my desk to remind me that in the 30 months of the 1930s the Dow fell 86% but had seven rallies each averaging 24%. Slide 6: Four Exogenous Events: • Sovereign Debt • Demographics • Protectionism • China S There is a long list of potential outliers that could create road blocks for the world’s economy, but I will make some brief comments on just four for the sake of time, since each carries a risk to the global financial system and hence business activity. Slide 7: The cost of the Banking Crisis (Reinhart & Rogoff estimates) De Defi fici cit Pr Projected B Bond (% o (% of G GDP) Issuan ance ( ($billi billion on) IMF Estimate 27% $10,239 Rogoff, Best Case 40% $15,309 Rogoff, Average 86% $33,029 Source: CIA World Fact Book, IMF, Rogoff & Reinhart Taken from Niels Jensen, Absolute Return Partners LLP It really is quite easy to see where the next crisis will come from by searching for where leveraging is being created today. History shows that yesterday’s credit crises often morph into tomorrow’s government debt crises. The cost to governments of financing this pile will be high in terms of real interest rates and the ability to raise those funds without offering greater real returns than equity markets can offer. Indeed, the Greek crisis is an early warning that sovereign balance sheets are in play. 4
Slide 8: The US Debt Overhang S Source: Boeckh Investments Inc. The central issue, as we all know, is deleveraging, a dynamic that has years rather than months to run. Households are going to continue to save, forsaking the borrowing creed of the past two decades. The implications in the Old World, which consists of N America, W Europe and Japan, of households hunkering down are far reaching. GDP growth slows, imports from Asia and elsewhere slow, savings rise and so on. And they are just as significant for China and the rest of Asia given their dependence on exports to the Old World. Slide 9: The Age of the Aging US USA % Populat % Po lation W. W. E Europe rope % P Popu pula lati tion + 65 65 ye year o olds lds + 65 ye + 6 year olds 1950 19 13,042 13 42 8.3 8.3 14 14,462 62 10.3 10 1960 19 17,117 17 17 9.2 9.2 17,315 17 15 11 11.4 19 1970 20,603 20 03 9.8 9.8 21 21,683 83 13.0 13 1980 19 25,722 25 22 11. 11.2 24 24,915 15 14 14.6 19 1990 31 31,438 38 12.3 12. 25,546 25 46 14.5 14 2000 20 35,621 35 21 12.4 12. 29,265 29 65 16.0 16 20 2010 41,155 41 55 13.0 13. 34,712 34 12 18.4 18 20 2015 47,617 47 17 14. 14.3 37,735 37 35 19.9 19 2020 20 55,748 55 48 16. 16.1 41 41,064 64 21.5 21 2025 20 64,951 64 51 18.1 18. 44,765 44 65 23 23.5 S I have borrowed the title of this slide from George Magnus’s excellent book. A decade or so of deleveraging is starting during a period when yesterday’s baby boomers are becoming tomorrow’s retirees. Whilst the age group of 65 and above is growing alarmingly in the USA, the numbers are quite frightening for W Europe. Focussing on rising home values and equity markets as the rump of savings for retirement have now been skittled down the alleyway to be replaced by a desire to build more cash 5
savings and a search for income. One affect of this rising dynamic may well be a fundamental switch from equities to government bonds over the coming decade, another megatrend in the making, one which is an integral part of the age of frugality and austerity which I believe lies ahead of us, or as Thomas Friedman wrote recently, “ There are no more fat years to eat through”. Slide 10: Herb Stein’s Law: “What Cannot Go On Forever, Won’t” S Now almost everyone is extrapolating debt and government deficits to the skies. It was not so long ago that most people, including the US government, were forecasting budget surpluses forever. Remember Herb Stein’s law, “What cannot go on forever, won’t”. The age of borrowing beyond ones means and the profitability of Wall Street, often at the expense of Main Street, are fast approaching their end, as profits will switch from the former to the latter and saving replaces borrowing. Household savings, together with government bonds beginning to offer better real returns over time, will enable these deficits, not only to fall, but for the USA to have the capacity to finance them domestically. It is a part of the New World, whose structure will undergo quite radical changes over the next decade. A significant part of this change will be the revitalisation of manufacturing in the USA. Slide 11: 6
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