It has been a rough week for commodities, with iron ore and copper falling on worries over China. Like iron ore, copper has also come under pressure due to trade financing deals in China that use the industrial metal as collateral. Copper miners have had a fairly difficult time since 2008, as both challenging macroeconomic environment along with supply glut have hurt copper prices and the top-line growth. With the exception of 2011, when copper prices rose sharply, thanks mainly to strong demand from China, the demand for the metal has remained subdued, weighing on the financials of companies such as BHP Billiton (NYSE:BHP), Freeport-McMoRan Copper & Gold (NYSE:FCX), and Southern Copper (NYSE:SCCO). More importantly for these companies, the outlook for copper is not very encouraging in the wake of weak demand and an expected supply glut.
Copper prices fall sharply
Earlier this week, copper prices fell to a near four-year low after China reported weak trade data for the month of February. The trade data follows some other weak Chinese economic data, highlighting the slowdown in the Chinese economy. Copper prices have struggled this year after falling about 7.4% in 2013 as global supplies continued to outpace the demand. The fall was contained as demand for the industrial metal turned out to be slightly better than expected.
Weaker copper prices had a negative impact on miners' financial performance. Earlier in February, Southern Copper reported nearly a 24% fall in net income and 7% contraction in sales on a year-over-year basis for the fourth quarter of 2013 due to fragile demand for copper and lower prices.
Freeport, the world's largest publicly traded copper miner, also felt the pressure. The company's fourth-quarter 2013 profit fell to $0.68 per share from $0.78 per share reported in the same period in the previous year.
The Anglo-Australian miner, BHP Billiton reported robust 60% increase in its revenue from the iron ore business for the first six months of the current fiscal year, but its copper business showed a meager growth of 0.4% in the same period.
Interestingly, however, lower prices haven't deterred copper miners enough to stop or lower the production volume. According to Barclays Capital copper output increased 9% in 2013 to 10.6 metric tons. And this trend is likely to continue in 2014. Southern Copper plans to grow copper output to 672,400 tons in 2014, up from 637,068 tons in 2013.
Freeport also plans to raise its copper production by 7% in 2014, notwithstanding feeble demand. Chile, the world's largest copper producing nation and home to major copper miners, raised output by 6% in 2013, and the trend is expected to continue in 2014.
Does that imply that copper miners expect the demand for the industrial metal to pick up in 2014? Are prices likely to rebound? It looks improbable in the foreseeable future.
Outlook for copper prices weak
One of the major reasons why outlook for copper demand is weak is China. The world's biggest copper consumer is witnessing a slowdown in its economic activities. As I have discussed in previous articles, the slowdown is partly due to Chinese policymakers' efforts to rebalance the economy. As a result, China's Purchasing Managers Index (PMI) slumped to a seven-month low in February, according to HSBC.
March's trade data, released earlier this week, was the main reason behind the sell-off in copper and iron ore. The trade data further highlights China's focus on rebalancing the economy.
Adding to concerns is the financial health of Chinese companies related to the property sector. Several financially stretched firms have used copper as collateral to obtain funding. A sharp drop in copper prices is likely to trigger margin calls from lenders, putting further pressure on prices.
Given that China accounts for over 40% of global copper demand, any weakness there would have a significant impact on copper prices. Moreover, other emerging markets such as India are also weak, which will further dent demand. Additionally, in the U.S., recent data from the housing market has been mixed. Part of it has been weather-related; however, some weakness can also be attributed to higher mortgage rates.
The weak demand comes even as there is likely to be a supply glut in 2014. As I noted before, copper producers are expected to ramp up production in 2014. But if demand from the world's biggest consumer of copper remains weak, then there is expected to be a significant supply glut. This would keep copper prices under pressure, which is bad news for miners such as Freeport-McMoRan and Southern Copper.
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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.