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Copper: topped out?

Seemingly boundless demand, supply constraints and chronic underinvestment – is the copper market too good to be true?
February 1, 2018

Here are a couple simple observations about the price of raw materials. One, correctly calling the price of a metal shouldn’t feel simple; two, the rules of supply and demand should prevent the price of a commodity from continually moving in one direction. But ask nearly anyone in the mining world right now, and the view on copper is bullish. Net futures contracts for the metal are currently at a multi-year high, exchange traded product inflows are surging, and the large diversified majors are all beefing up their production commitments for 2018 and beyond. Even Glencore (GLEN), habitual contrarian of the mining world, is banging a drum made of the red metal.

It feels like the point at which investors should be getting nervous. Or should they? “We’ve gone through this odd period over the last few years, where the fundamentals have looked good, but there’s been no price reaction and little improvement in sentiment,” observes Nitesh Shah, commodities strategist at ETF Securities. “Now that is changing, and the supply deficit has started to become increasingly apparent.”

Analysts at BMO Capital Markets take a similar view: “The supply-drive copper deficit which has been ‘three years away’ for much of the last five years is now only 18 months from coming to fruition.” So, do investors have a near-guaranteed bull market in front of them? After falling below $5,000 (£3,500) a tonne at the end of 2015 (equivalent to around $2 per pound), tighter supply and rising demand has since pushed copper prices to $7,000 a tonne. That’s quite a re-rating to begin with, even if it falls short of the dramatic rally between 2009 and 2011, when copper prices tripled. But the idea of a further correction, so soon after half a decade of supplier pain, is almost stupefying.

 

China crisis?

Then again, the strength of any commodities rally is not only due to buyers’ rush to secure inventory, but the length of time the market spent fretting in the downturn. Three years ago, the world was awash in copper, and markets were concerned about stalling Chinese consumption. After the splurge of commissioning earlier in the decade, capital expenditure was largely cut – and remains depressed, among the largest miners at least. But by next year, when First Quantum Minerals (Ca:FM) humungous Cobre Panama mine begins production, there will be no mega-projects left in the pipeline.

Added to this, demand is back. Although China’s copper consumption is expected to moderate alongside less commodity-intensive economic growth, infrastructure spending remains strong. In almost all industrial economies, demand is growing and further underwritten by the much-vaunted switch to electric vehicles. Barring major mine disruption, failed negotiations with Chilean unions, or a serious global economic downturn, BMO expects refined copper supply to match demand at 23.8m tonnes in 2018. Thereafter, output flatlines, a deficit emerges and inventories sharply decline.

 

Mines in line

Such a favourable outlook has clearly caught the attention of London’s mid-tier copper miners. KAZ Minerals (KAZ), the most spectacular beneficiary of a tightening market in the metal, is doubling down on growth. After a seamless ramp up of its two development projects, the Kazakh miner gave the green light to a $1.2bn expansion to its Aktogay plant, which will double sulphide ore processing capacity from 2021. Assuming the tenge holds firm, net cash costs are forecast to be maintained at an impressive $1-$1.20 per pound of copper, and will be funded by strong cash flows from Bozshakol and existing production at Aktogay.

No less positive on the outlook for copper is Atalaya Mining (ATYM), even if the Aim-traded group’s concentrate production is too small to move markets. At the beginning of December, the group announced a £31m equity fundraising to expand annual output from the Proyecto Rio Tinto mine by 15,000 tonnes of copper concentrate. Construction for the upgrade – which will cost €80.4m (£70.8m) – is due to start next quarter, and should come online in the second half of 2019.

And though Central Asia Metals’ (CAML) Autumn fundraising was principally for the purchase of Macedonian zinc-lead miner Lynx Resources, institutional investors who coughed up £137m for the deal will have no doubt been assured by the group’s low-cost copper operations at Kounrad, also in Kazakhstan.

London’s two largest miners are also increasing their bets on copper. A fortnight ago, Rio Tinto (RIO) announced plans to increase its share of mined copper production to between 510,000 and 610,000 tonnes, after output dropped at its Kennecott, Escondida and Oyu Tolgoi mines in 2017. This bet on the red metal is not without its obstacles. Escondida has proved an unpredictable source of earnings, while a recent $155m claim from Mongolian tax authorities – following a raid by immigration officials last year – has rocked some investors’ confidence in Rio’s plans to expand its operations at Oyu Tolgoi. The company is also expected to sell its stake in Freeport’s Grasberg mine, which generates little in the way of attributable revenue but is worth at least $1bn.

Meanwhile, BHP Billiton (BLT) is keen to make up for ground lost to last year’s strike at its majority-owned Escondida mine, with plans to boost full-year copper output by between 25 and 35 per cent, to as much as 1.79 million tonnes.

 

<boxout><title>The broker's view<title>

Go east

In copper, the Chinese commodity business model of ‘buy raw material, build process capacity and export downstream products’ still holds true.

With the strength in copper mine supply growth over the 2012-16 period, most notably from Chinese-owned mines in Peru, China’s copper concentrate imports have more than doubled since 2012, and overtook refined copper imports in terms of copper content in 2016. However, 2017 saw imports essentially flat year-on-year, following the well-documented problems in global mine supply.

As such, any recovery in concentrate imports this year to offset falls in scrap is highly dependent on global mine output. We do see a return to growth here in 2018, but only around 1 per cent after disruption. However, given the expectation of increased scrap consumption outside of China, this will free up concentrate units. Given this, we expect China to import around 500kt more copper in concentrate in 2018, which on paper is enough to balance the books.

Even factoring in normal disruption of 4.2 per cent, there is always the potential for copper mine supply to disappoint. Already this year we have seen a 10 per cent fall in contract treatment and refining charges, which implies a tighter concentrate market. For imported materials, the spot charges are even less, which we believe reflects both expectations of better copper demand over the coming months and restrictions on Chinese domestic copper output due to both environmental and weather-related reasons.

Indeed, given China produces around 1.5mt of mined copper a year, this is perhaps the biggest potential "disruption" risk in 2018. Such a problem would accelerate the emergence of a strong refined deficit, something we currently expect in mid-2019.

We would also note that China’s willingness to import copper is in part down to the plentiful smelter capacity installed. However, should new capacity shift to a ‘one-in, one-out’ model for copper smelting concentrate demand, growth would certainly stagnate. We see some potential for this on a two to three-year view, with the net effect being to improve smelter margins and tighten the refined market until non-Chinese capacity responds.

Colin Hamilton, industrial metals analyst at BMO Capital Markets<title>