February 17, 2019

Copper-bottomed Forecasting

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 Who do you think would make the better economic forecaster?

Or this?

Tubo di rame - Foto Giovanni Dall'Orto

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The reason I raise this question is because of an interesting article about copper, “Red Bull”, in the Economist (September 24, 2011) subtitled “the world’s most informative metal”.

Now “informative” is guaranteed to attract an economist’s attention, because economics in general and the price system in particular is really all about information. The article says copper has been nicknamed “Dr Copper” by some “because of its supposed ability as an economic forecaster …. the metal’s price movements are widely believed to prefigure shifts in the world economy”.  

Why? Just as in the Oil Price Watch Overview, expectations and inelasticity played their part. The Economist notes that that copper demand is expected to rise by 40% by 2020, and as in the Oil Price Watch Overview this may be feeding back to affect current demand and supply, and pushing up prices now – as we said in the Oil Price Watch, “In a very real sense, commodity markets today echo the future”.

The Economist also notes it is expensive to expand existing copper supply and difficult to find new sources (suggests inelastic supply) and it has few good substitutes (suggests inelastic demand).  This can mean price volatility but crucially also makes it a very sensitive indicator of underlying trends.

However, the Economist article does not say how Dr. Copper performs as an economic forecaster in the long run.  It just says most of the easy (technological) substitution has been done and that many analysts think high prices are here to stay because of increasing demand from China.

But the Economist’s own graph of copper prices shows that by 2000, real copper prices had fallen to around one-third of their 1970 level – and this was over a period when world GDP rose between 3-4 times its 1970 level. So Dr Copper failed miserably as an economic forecaster over that long term.

We know why, it is discussed under Issue 6 in the Oil Price Watch Overview.  In copper’s case the reasons included technological substitution (from fibre-optics, plastics, aluminium) stimulated by the incentive of high copper prices.

And now real copper prices have shot up over the past decade back beyond 1970 prices to five times their 2000 level. Will these high prices stimulate new bouts of technological substitution and falls in price or will growing demand from China keep prices high as the Economist thinks?  We do not know yet, but the lesson of history is that it would be a mistake to underestimate the incentive effect of high prices stimulating technological innovation and substitution.

So, bottom line, what’s to stop Dr Copper replacing an economist? Well, at the forecasting level we humans may not do any better, but we are still a heck of a sight cheaper – in the short to medium term at least …