Substitution Effect
Whenever i read a john mauldin article, I hope to picked up something that supplements what i know, meaning things i don’t. Substitution effect was somethign thought to me long ago, yet without practice, we don’t apply it in any way in our daily lives, much less investing. The following is what interest me in his latest Thoughts from the Frontline.
Copper: The Metal with the PH.D
Copper prices have been increasing rapidly in the last five years. From a low at $.63, today copper is $3.43. It was close to $4 last spring. This has not been a steady rise. The chart below shows that prices have risen rapidly in the last 2 years. (Chart courtesy of my friends at www.kitco.com)
What is the reason? China, strong growth in US housing and solid world GDP growth. Copper is said to have a Ph.D in economics. When copper prices are rising, it means that the economy is booming. But copper may be too smart by half. It may be pricing itself out of the market.
A new report by Simon Hunt, one of the true experts on copper, suggests that copper demand could actually drop over the next three years as companies figure out ways to substitute cheaper metals for copper. With copper trading almost 6 times it low just a few years ago, there is ample reason.
In economic terms, it is called substitution. If beef gets too high, we switch to pork or chicken. While it is a lot harder to switch the metals you use in a product, it is the same principle.
But ” … substitution is not just the use of an alternative material to copper. It is also the ‘need to make more with less’ through micro-miniaturization, improved design techniques, optimization of materials usage, improved fabrication methods, greater attention to end-product weight and the use of lower copper containing alloys.”
As an example, air conditioning manufacturers use about 900kt (kilotons) of copper a year, or about 5.4% of global usage. Two-thirds of that is in copper tubing. They are now working to use thinner and smaller pipes, which will reduce the amount of copper per tune by 25%. In China, they are using aluminum for external tubing.
New designs have air conditioning systems which use all aluminum. Smaller and newer manufacturers which do not have large investments to write off are beginning to produce these new models. They may be able to price them very competitively, forcing larger manufacturers to follow suit.
Even without the new models, global demand for copper from air conditioning manufacturers could drop as much as 300kt in the next three years.
Refrigerators, copper boilermakers, gutters and roofing, telephone wires, cable, and a host of other products are being designed to use less copper. All told, we could see world wide demand drop by almost 15%, and as much as 20% longer term.
Even in a world where GDP is growing, we could see demand for copper soften. Of course, this means that other metals, especially aluminum, will see there demand increase. The old line that the cure for high prices is high prices is true.
And that Ph.D in Economics? It may be as useful as a real one when it comes to making predictions.
Related posts:
- Thrift to Disastrous Effect
- Copper leads the equities?
- Ting Hai Effect Strikes the Stock Market Again!
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