The Copper Connection

For the first time in months, crude oil is actually showing signs of life. The price of a barrel of crude oil closed Friday up about 10% from its lows earlier in the week. Of course, we have to keep a little perspective here — it’s still trading at less than half its summer highs.

Have we seen the bottom in crude oil? Maybe, maybe not. I’ll leave the forecasting to Harry Dent. (Harry sees the price falling to $32 in the near term, by the way.)

Instead, I want to focus on what the drop in the price of crude oil is telling us about growth prospects.

Let’s start with the notion that the crude collapse is a “supply issue” rather than the result of sagging demand. Yes, the fracking revolution has turnrned the U.S. into an energy powerhouse again.

In the chart below, you can see that our crude oil production is up 45% since 2000. Russia and Canada have seen even bigger boosts to crude production, up 56% and 78%, respectively.

Image Oil Chart

Source: U.S. Energy Information Administration

See larger image

Yet production has collapsed in several traditional producers, such as Norway, Mexico, the United Kingdom and Venezuela. Overall, world output is only up about 13% since 2000. That’s less than 1% per year.

I don’t know about you, but I wouldn’t call that a supply glut.

And it’s not just crude oil that is flashing warnrning signs. Retail sales were lower in December…despite the drop in gasoline prices that was supposed to give consumers extra cash to spend.

The 30-year Treasury bond yield hit new all-time lows last week — yes, as in the lowest yields in history — and finished the week yielding 2.44%. And core Consumer Price Index (CPI) inflation, which excludes energy and food, came in lower than expected at 1.6% for the year.

Does any of this sound like a healthy economy to you? I say no, it doesn’t.

In Boom & Bust we’ve been mostly out of the oil trade. But we have been actively shorting copper, which is one of the most economically-sensitive commodities due to its use in construction. New construction accounts for about 44% of copper use. And given China’s place as the center of construction activity, about 45% of the total is used by China.

China is the copper market. And guess what? Even if China avoids a hard landing, Chinese demand for copper is about to fall off the cliff.

About one out of every five new homes in China is currently sitting unoccupied, and Chinese construction is slowing. But we actually don’t need Chinese construction to completely grind to a halt in order to have a bear market in copper.

Supply of new copper has outpaced demand for several years running, with much of the excess sitting in Chinese warehouses. Figures here are a little shadowy, but China’s Strategic Reserves Bureau is believed to have purchased as much as 700,000 tons in the first nine months of 2014.

China is practically swimming in copper.

Meanwhile, copper prices continue to slide. Copper started 2015 at $2.84 per pound before sliding to as low as $2.55 last week. In the January issue of Boom & Bust, Adam wrote that copper prices could eventually fall to $1.00-$1.50… that’s where they sat a decade ago.

If China ends up having a real slowdown, that might prove to be a conservative estimate!

Is Dr. Copper predicting a recession in 2015? Probably not. I expect the economy to grow this year. But I also expect it to fall short of the 3% growth currently being forecast by economists.

We’ll keep an eye on it.