A quick test. From the following price changes, identify the odd one out: 26 per cent, 37 per cent, 11 per cent, 36 per cent, 32 per cent, 27 per cent and -1 per cent. If you chose the last option, then congratulations, and award yourself a bonus point if you correctly identified the only base metal to lose value in 2016. While short-term future contracts and spot prices for gold, silver, aluminium, steel rebar, zinc and tin (in that order) have all surged since January, copper is the only major metal whose price has pared back. Even more confusingly, it was one of the few commodities in which analysts predicted a deficit this year. So what's happened? And why have many copper miners managed to defy a painfully low pricing environment by beating swathes of the market? Most importantly, how much pain is there ahead for producers?
Definitive answers, as is often the case with commodities, are best found in hindsight. As the graph below shows, the story of copper's drop began to gather momentum in early 2013, when prices were still north of $3.50 (£2.68) a pound. It was around that point that domestic production from China - for some time the world's single largest consumer of the metal - started to exceed projected consumption growth. Since then, Chinese demand has slowed, while the country's stocks have remained high.
In 2015, prices declined by 25 per cent as global markets were gripped by intensifying concerns over Chinese growth, even if new supply was offset by power outages in Zambia. That trend reversed in the first half of 2016. According to Bloomberg Intelligence, demand in China increased by 12.5 per cent, egged on by a rise in aggregate loans and a more active property market and firmer orders from the power and construction sectors, while European and US demand has also been buoyant. At the same time, 1.12 million metric tons is gradually being added to global supply, suppressing any price increases.
In balance
That ramp-up is finely poised, with delays in African production and shut-ins in China compounded by depleting mines and falling grades in Chile, by far the largest single source of output. Offsetting all of this has been Peru's much publicised output growth this year - including increasing mining at MMG's (HK: MMG) Las Bambas project and a doubling in tonnes mined at Southern Copper's (US: SCCO) Toquepala open pit project, the globe's fifth largest mine. Given this fragile balance, a halt to the five-year price slide has probably been one of the strongest signals of a bottoming market. Nonetheless, investment bank Macquarie - which has forecast flat copper prices for the next three years - points to static concentrate treatment and refining charges in China as a signal that physical markets remain weak.
All of which begs the question: why have copper miners' shares done so well this year? In the case of several of this year's big risers - Rio Tinto (RIO), BHP Billiton (BLT), Glencore (GLEN) and Anglo American (AAL) among them in London - the simple answer is that the price increases of many other commodities have helped to a greater extent. In other words, the copper cost savings achieved by the diversified producers has been outweighed by metal price rises elsewhere.
Other miners with a greater proportional exposure to copper have been helped by sales of gold - a typical by-product of copper mines - in a year in which the value of the yellow metal has sky-rocketed. This has been the case with two of the largest London-listed copper plays, KAZ Minerals (KAZ) and Antofagasta (ANTO), which have also benefited from the devaluation of the Kazakh tenge and the Chilean peso, respectively. These factors - together with operational austerity and a focus on efficiency that has enveloped commodities markets in the last few years - explains why the whole copper sector has been pretty effective at reducing costs. As this has been largely achieved without sacrificing production, it's not hard to work out why prices have remained stubbornly low.
Where next for prices?
Most sector watchers believe copper will eventually hit a huge deficit, but over-supply and tepid demand will remain the dominant themes in 2016 and 2017. In the short term, Liberum analyst Richard Knights believes the market has underestimated copper's reliance on China's wavering demand for property, which uses a high amount of the metal in wiring and construction. "You see various numbers, up to as low as 20 per cent about how exposed copper demand is to Chinese housing; I think it's probably north of 50 per cent and that's a function of things like air-conditioning units, and the copper-intensive part of state grid spending," says Mr Knights. "The problem we have is simply too much Chinese housing stock, particularly in the lower-tier cities."
This dynamic could mean prices are unlikely to pick up this year, but assuming demand does not fall off a cliff, analysts at RBC Capital Markets are predicting a sharp swing to deficit in 2018. This chimes with predictions from Codelco and Freeport-McMoRan (US: FCX), the two largest copper producers by volume, which see the dramatic thinning of major new projects this decade as a serious impediment to the global supply pipeline. Others such as BHP Billiton, which operates the Escondida project in Chile, believe the market will take longer to shake out the excess capacity.
Favourites
Low copper prices have mattered little to Central Asia Metals (CAML), owner of the low-cost open-pit Kounrad mine in Kazakhstan. The company uses a process known as solvent extraction-electrowinning to turn so-called 'waste' dumps of low-grade copper sulphides into a product which meets the London Metal Exchange's requirements for A-grade copper. This is done at staggeringly low cash costs of 60¢ a pound. In turn, that has allowed Central Asia Metals to commit to pay out at least 20 per cent of revenue as dividends. This year, the company managed to reward shareholders with a return equivalent to a massive 26 per cent of 2015 revenue, leading analysts at Peel Hunt to upgrade future dividend forecasts to give a roughly 7 per cent dividend yield for 2016.
CAML's Kazakh neighbour, the highly leveraged KAZ Minerals, has struggled through a period of investment, but now looks set to benefit from cost-cutting initiatives and lucrative silver and gold by-products. Ramp up at the new Bozshakol mine started earlier this year without incident and should help to bring full-year output to as much as 55,000 tonnes of mined ore. At that rate, analysts are predicting earnings of 38¢ a share in 2017, putting the stock on a PE ratio of six.
Outsiders
We are keen on small-scale producer Atalaya Mining (ATYM), whose Riotinto project in Andalucia is currently being severely undervalued by the market. The company is trading at just seven times next year's forecast earnings, unwarranted given the company's excellent infrastructure and track record of ramping up production under budget. However, the threat of a dilutive fundraising, and a higher cost profile during its expansion stage mean the market has its doubts.
Having recently brought its copper costs down to below $1 per pound, there's little doubt that Glencore is doing all it can to eke out as much cash from its scaled-back portfolio. But London's largest copper miner by volume is so focused on reducing its debt pile that it's difficult to see whether the disposal of profitable assets now will leave good operating cash flows further down the line.
