Boom or supercycle?

Growth on top of current metals prices would see mining company earnings explode. The commodities that have hit decade-long highs or record highs in the past two years include gold, copper, iron ore, silver, palladium, rhodium, and more. An industrial boom beyond the Covid-19 recovery could push these higher. Mining investors have already had a taste of this, and BHP (BHP) and Rio Tinto (RIO) are already easily outperforming most of the FTSE 100.

Rio has a forward dividend yield of 10.1 per cent, BHP’s is 7.6 per cent, compared with the FTSE 100 average of 3.8 per cent, and their total returns have surged already. 

To cite one of the originators of the boom idea, Goldman Sachs analyst Jeff Currie, we’re in for a structural shift in demand, which make it a supercycle. In a recent interview, Currie said this supercycle would be like what was seen in the 1970s. 

“This is a very similar set-up to what we had in the mid-1960s, that created that structural bull market, or supercycle, in the 1970s,” he said in an interview with S&P Global Platts in February. 

Fellow star analyst Marko Kolanovic, at JP Morgan, said in February we were in the upswing phase of the supercycle after 12 years of “contraction” in cycle terms. The last one ended in 2008, he said, although others say it lasted until 2014.

Currie points to three facts that are similar to our present moment: there are redistributional policies, environmental policies and “versatility in supply chain initiatives” driving commodities demand. 

The comparative lead-up was the 1960s, in the US, which saw the war on poverty launched by LBJ, and the war on acid rain that saw sulphur removed from petrol. The supply chain dynamics come from the Cold War, which drove the US to build up a strategic reserve of materials. 

Now, the redistributional policies are the trillions in global stimulus spending, the environmental piece is the green-led pandemic recovery and existing energy transition spending and the supply chain kicker is China's hoarding of strategic reserves. The previous supercycle in the mid-2000s was more simple. It was driven by China’s rapid growth and huge levels of government spending. 

Further back, other supercycle examples are Britain’s industrialisation (although over a much longer period), the US rail boom between 1871 and 1894 and Japan’s post-second world war reconstruction, from 1950 to 1970. Each is identified in 'China: The Engine of a Commodities Super Cycle', a famous 2005 note by Citibank analyst Alan Heap that declared a supercycle was on.  

So this is about more than China ramping up electric vehicle (EV) production and apartment building; a supercycle indicates truly massive global changes. But Xi Jinping’s plans for his country to aim for net zero carbon emissions by 2060 adds much credibility to the supercycle theory. 

“When President Xi announced the country’s carbon neutrality goal...he was giving notice of the complete transformation of its economy and how it produces, transports, and consumes energy,” says Wood Mackenzie research director Miaoru Huang. 

This will be a mammoth effort, given China consumes 4bn tonnes of coal a year and is the world’s leader in highly-polluting steel and cement manufacturing. The new low- or no-carbon power options alone would cost $6.4tn, according to WoodMac. In the short term, the International Energy Agency (IEA) sees China’s coal generation rising by some 180 terrawatt hours (TWh) in 2021. This will be the largest rise since 2018, when generation rose 300TWh. 

Outside China, Europe’s commitment to building its own EVs and the new Biden administration’s $3tn stimulus package will also drive demand for commodities. Huge amounts of metals will be needed to both build the cars and the infrastructure needed to charge them. 

At an investor level, a supercycle would bring even greater profits for miners and inflation for many other company holdings. 

Currie thinks copper could be a $50,000/t commodity, which would jack up prices for consumers. Air conditioners, fridges and other home appliances all need copper, while the average EV has around 80kg of copper, according to the industry group the Copper Alliance. 

This wouldn’t happen in a bubble, however, with a stronger US dollar cutting the real costs of higher commodity prices. Lower oil prices in the long term would also cut corporate costs globally, although it’s possible oil supply will fall more sharply than demand within a few years, as financing gets tougher for projects. This is one of Currie’s theories. 

The middle ground 

The supercycle argument is whether the current price highs, which are driven by short-term supply and demand, will turn into record prices across the board because of the energy transition. 

ING head of commodities strategy Warren Patterson told Investors’ Chronicle that China could start slowing its spending and stop the supercycle talk in its tracks this year. 

“So the big question is [are the current prices] sustainable moving forward? And I think that's where it gets a little bit more interesting,” he said. “There are suggestions that we will start seeing China resuming its deleveraging campaign, I think that is something that's very likely to happen, given the fact that they wouldn't want their economy to start overheating.” 

China consumes just over half of the world’s commodities, so the government cutting back lending to industry would make a significant difference to prices. 

A fellow sceptic is Ben Davis, an analyst at Liberum. He thinks what we’re seeing now is just a supercycle-esque recovery. 

“We believe that 2020-21’s broad-based commodity rally resembles those of 1984, 1991, 2001, 2009 – in terms of scale of lift from base, and occurring immediately after a global recession,” he said in a March note.

In part this reflects slightly different definitions of what a supercycle constitutes (see boxout for further detail).

But Currie, Davis and Patterson agree the energy transition will have an impact on commodity prices. There is a way to sit on the fence on this question.

Even if a supercycle does not occur and copper and iron ore prices fall back closer to the cost of production (as Davis forecasts), there are plenty of investment opportunities to back the energy transition, beyond just throwing money at Tesla (US:TSLA). 

Bull-ish

If we take the view that commodity prices will stay high enough for most investors to justify adding to their mining holdings, either through individual companies or ETFs, then it’s worth working out which metals will do the best out of a continued bull market. 

Copper is the obvious choice given its transition uses, while nickel has similar appeal but is rarer among the majors. Iron ore has been strong for over two years now, above $150/t, but prices are widely expected to fall from 2022. 

Macquarie Bank and Liberum have the metal falling below $100/t next year, which would mean big dents to Rio and BHP’s profits. 

The mining industry has long pitched copper as heading towards a supply deficit, and so existing operations would have supercharged profits further into the 2020s. Given copper’s current highs, even maintaining the $9,000/t level beyond this year would be enough to confirm a bull-plus market.

Global X ETFs' head of research Morgane Delledonne takes a view that copper is worth backing in the short term because of US infrastructure spending and supply uncertainties and as a hedge to rising inflation. 

“We have seen in the past that copper is one of the best-performing assets when there are inflationary pressures,” she says. “But beyond this near term, I'd say macro conditions of rising inflation and reflation trades, the structural changes for copper that will lead to potentially higher prices in the future are the acceleration of electrical vehicles adoption, and also the infrastructure spending.” 

Delledonne also underlined China’s “very deep and long-term focus” on building infrastructure as a driver, while some analysts say demand will drop off shortly as the market gets out of undersupply. Davis has copper on his “avoid” list for the next 12 months, but sees mine supply issues as driving the market in the longer term. 

“We expect the market to return to balance later this year, with a persistent modest surplus weighing on the medium-term price outlook,” he asserts. 

For context, copper falling below $7,000/t would largely be a return to the status quo, given mines are mostly built to be profitable under $6,000/t.

Some low cost producers, such as Central Asia Metals (CAML), are well below that level, so even for supercycle sceptics, the sector is worth looking at. WoodMac’s base case demand forecast for the next 20 years is 2 per cent growth a year. This means the world has to find an extra 9mt a year by 2040. A scenario where the world tries to hit the Paris climate goal of a maximum two-degree rise in temperature compared with 1990 would bring on growth of 3.5 per cent a year, doubling demand growth over 20 years compared with the base case. 

The largest copper mine in the world, Escondida in Chile, produces just over 1mt a year. 

The mining world has known for a long time it would start running into trouble with copper supply and demand dynamics, but a lack of major discoveries and a weak market between 2015 and 2019 meant exploration was limited. WoodMac said investors clamouring for the “dividend drug” are partly to blame for this. 

Taseko Mines (TKO) president Stuart McDonald sees the industry continuing to move to lower grade or harder-to-mine deposits. 

“When you have demand growth every year, you know, from emerging markets, from electric vehicles, from renewable energy and electrification, that all needs new copper and new mined supply,” he said. “And so in order to [find] that, you've got to go to lower grade deposits and sometimes you have to go to more challenging jurisdictions around the world.” 

His company has snagged a new mine in the US, but is using a mining technique that would be more familiar to oil and gas companies, where wells are dug and the copper recovered in-situ by dissolving the rock and then pumping up the solution, which is then turned into copper cathode. 

Even with the undersupply situation within a few years – as per WoodMac forecasts – London’s copper miners do not have easy projects to throw a few hundred million dollars at in exchange for a 100,000t-a-year mine. Rio has shown this with its troubled Oyu Tolgoi project in Mongolia.

This was hailed as a major new discovery 20 years ago, which was true, but getting it right is proving tough and expensive.

The difficult of building a mine has even been used to justify delisting Kaz Minerals (KAZ). The chairman, Oleg Novachuk, believes investors will not stomach the $8bn price tag and years of development needed to get the massive Baimskaya mine up and running. The pushback from shareholders has proved this narrative is not so clear-cut, however. 

Substitution is not feasible currently because of aluminium’s poor conduction and greater risk in electric systems, so copper will remain critical.

London’s copper producers all offer something different. Antofagasta (ANTO) for large-scale production, Atalaya Mining (ATYM) for a smaller European option, Central Asia Metals for its low cost and consistent dividends. 

What else? 

The symbol of the previous mining boom was iron ore. Houses in Perth and in the Pilbara, home to the metal’s most profitable and prodigious supplies, became some of the priciest in the world from the mid-2000s, while the cost of a coffee in Western Australia could shock even those used to sipping espressos in Mayfair. 

Iron ore got near the $200/t mark in 2011, but new supply came on and prices dropped. This is the usual cycle.

Davis at Liberum said iron ore would likely be subject to these usual pressures, given the mining industry’s ability to expand supply and the likely recovery in Chinese scrap supply. 

There are a few more interesting options than iron ore anyway, in terms of supercycle-ready investments. 

Delledonne at Global X has picked uranium as a winner despite questions over its green credentials. She sees it as a low-carbon option ready to be rolled out. “[Nuclear] has large-scale potential for energy output, but also the cost is aligned with traditional fuel energy production cost like few of your stations,” she said.

“We do think there is a lot of opportunity in the nuclear space, and the bad reputation of nuclear power since what happened in Fukushima is abating with time.” 

Supercycle-agnostic options include key EV materials such as nickel, lithium and cobalt. Manganese also got a boost in March as Volkswagen outlined its massive EV ramp up.

A much more counterintuitive pick for an energy transition winner is oil. Currie said a supercycle in which the dollar and bulk commodities push much higher could see oil back over $100 a barrel (bbl). As investors have seen in recent months, oil and gas companies have done well as demand recovers. This has been helped along by Opec and Russia cutting supply, which could swiftly come back on alongside a mooted recovery in air travel, for example.

Patterson at ING is more circumspect, at least in the short term, believing US production can respond to higher prices now compared with when oil was last at $100/bbl and Opec could quickly increase supply. Davis has oil flat on a five-year basis, but sees uranium as having the most upside over the next five years.

Oh yeah, climate change

Plunging into commodity research often leaves you stuck looking at individual trees. The woods in this scenario are climate change, and the reason the energy transition has to happen.

Investing in oil might be smart if you follow Currie’s thinking – just remember the Opec risk – but many investors have already shifted away from this sector for ethical reasons.

Similarly, building new mines all over the world would be a strange solution to the problem.

The holy grail here might be low-carbon copper or even a recycling option. EV ingredients will also change, and recycling was a key part of Volkswagen’s ‘Power Day’ presentation this month. Advances will also be needed to strip out at least some of the massive emissions involved in steel, aluminium and cement manufacturing.

Supercycle or not, we’re in for a thrilling ride in the next decade.