Chart Of The Week   November 23 2021

Copper Prices Defy The Greenback’s Strength

Copper and dollar at odds

Commodity prices and the US dollar tend to be inversely correlated. This relationship can be explained by multiple forces. First, a stronger dollar raises the local currency costs of commodities for foreign consumers and as a result leads to demand destruction. Moreover, a stronger greenback raises commodity producers’ local currency revenues from sales of USD-denominated commodities and thereby incentivize more supply at the margin. Finally, as a countercyclical currency, the US dollar tends to strengthen whenever the global economic backdrop deteriorates – which is also an environment in which demand for commodities softens.

However, this relationship has weakened recently. Copper prices are up 0.5% so far in November despite the trade weighted dollar’s 1.5% gain. The red metal’s performance essentially indicates that demand is exceeding supply and that this market imbalance is dominating the bearish impact of a stronger dollar. Indeed, global copper inventories have been falling and are currently extremely depressed.

The risk now is that copper prices may be nearing a turning point whereby higher prices choke demand and eventually lead to an inventory rebuild which would ultimately weigh down on prices. Not to mention that copper prices also face near-term headwinds from deteriorating property market conditions in China.

Nevertheless, the long-term outlook for copper prices remains positive. Our Commodity & Energy strategists have been arguing that due to years of underinvestment, copper supplies will be inadequate to meet strong demand from the buildout of renewable energy infrastructure. This supply-demand mismatch will push prices higher such that they eventually incentivize more capex investment to come online.