Copper is one of the most useful metals on Earth. It is an efficient conductor of electricity. It is flexible and strong and it doesn’t corrode easily. It is used for heating, air conditioning, plumbing, roofing, adapters, computers, cars, mobile phones, wiring, electrical leads, transformers, motors and lighting units.

In short, copper is used in nearly every major industry of the world: transportation, engineering, machinery and equipment, electrical, building, automotive and computer.

Thanks to significant demand worldwide, this base metal has outpaced all of its higher-profile precious peers by a significant margin over the last five years. Spot copper prices are up 393% from their lows in 2001. Meanwhile, gold is up only 151%, silver is up 188%, platinum is up 202% and palladium is up 122%.

Surely, copper prices have gotten way ahead of themselves and are due for a major correction. Right? That’s what the bears are saying these days. But the underlying fundamentals in the copper sector paint a different picture. They show a world in which prices will go higher — much higher.

World-famous commodities expert Jim Rogers said there are three questions you need to ask (and answer) to determine if a commodity is worth investing in: How much production is there worldwide? Are there new sources of supply? And are there new potential supplies?

The perfect scenario for a commodity on the rise is that worldwide production is limited or declining, there are no new supply sources that could boost production in the near-term and there is no viable replacement when prices get “too high.”

Based on all three requirements, copper is the perfect investment right now. See for yourself:

Is Production Limited or Declining?

Yes, thanks in part to rapid growth in India and China, worldwide copper demand is at an all-time high. Below is a table that shows the total amount of copper produced every year since 1998 compared with total consumption.

For the last three years, copper consumption has been greater than the total amount of copper produced. As a result, copper supplies and stockpiles have shrunk to five-year lows and copper prices have skyrocketed from 75 cents a pound to as high as almost $4.

Yet despite this growth, there is massive upside potential from here.

Japan consumes about 12 kg of copper per capita. North America consumes around 10 kg, and Europe consumes 9 kg per capita. But the massive populations in Chile, India, Eastern Europe and South America are all still consuming less than 2 kg per capita. Imagine what will happen to copper prices as they start to catch up to the rest of the world. Prices will rise — especially when you consider there is no major change to the supply side of the equation.

Are There New Supply Sources?

No, there has not been a significant new copper mine discovery in nearly 100 years. And according to the Metals Economics Group, “Worldwide, significant copper discoveries between 1998-2004 have fallen well short of what is needed to replace the copper produced — a total of just 39.9 million metric tons of copper in reserves and resources has been discovered, while production totaled just about 93.6 metric tons — although the resources in these deposits have potential for further increases over time.”

Think about that for a second…

Over a six-year span, only 39.9 million tons of copper were discovered, while 93.6 million tons of copper were produced. This ratio of production to discovery simply cannot sustain itself. If we don’t find a major new copper mine soon, copper production will have to slow down and prices will rise — significantly.

And a lack of new discoveries isn’t the only supply concern that can push prices higher. Labor disputes, political instability, natural disasters and major accidents can all wreak havoc on near-term supply issues. For instance…

The Escondida Mine in Chile is the world’s largest copper mine. It is responsible for 8.5% of global mine output — according to data from Chile and BHP Billiton (the mine’s owner). Workers at the mine plan to strike during the month of August if management won’t increase their wages. If the workers do strike, short-term supply will certainly eat into copper stockpiles — which are equal to only two days of global consumption.

Because there is no cushion in the copper market these days, any major or minor disruption in the copper supply chain will cause prices to rise. So that has some wondering if there is an alternative to copper — say, aluminum?

Will Aluminum Replace Copper as Prices Continue to Rise? No.

It seems logical to assume that demand for copper could go way down in coming years. After all, conductors, power cables and other wires are being made with aluminum – which is also a very good conductor of electricity, and is lighter and much cheaper than copper.

But how likely is it that everyone will all of a sudden stop using copper in lieu of aluminum?

The bears argue that copper is far heavier and more expensive than aluminum. True. But I would contend that that has always been the case. And in recent years, you can bet than anywhere it was feasible to replace copper with aluminum it was done. That’s evident by the rise in aluminum prices. Take a look:

But I would remind you that the increase in aluminum has not had any major effect on the demand for copper. In fact, demand for both metals has soared in tandem. And anyone who would have you believe that you could one day stop using copper altogether in lieu of aluminum should consider this one fact: If you took all the aluminum stockpiles in the world, it would only be enough for nine days of global consumption.

In other words, even if aluminum could be used to replace copper in every function under the sun (which it could not), you would only have enough to last nine days.

I don’t think copper is in danger of being totally replaced just yet. The developing world needs both metals — not just one.

A Bullish Scenario

At the end of the day, you have a very bullish scenario in the copper sector. There are very finite supplies, low stockpiles and any number of events that can stop production on a dime. Yet demand is at an all-time high and isn’t letting up just because supplies are dwindling.

Good Investing,

James
August 10, 2006

Copper is the Perfect Investment was originally featured in the Penny Sleuth.