Copper: Which Way Is Up?

Copper: Which Way Is Up?

By Jim Williams

Data by the Chinese customs administration showed on Monday that China’s exports surged by an annualized 9.4% in August, while imports contracted by 2.4% after sliding 1.6% in July.  Copper contracts for December, the most-traded contract in New York, stood at $3.1975 per pound, up 0.88%.

Imports of copper were unchanged at 340,000 tons. This is positive news for the red metal, as a sharp fall had been expected.

copper-090914Investors now turn their attention to upcoming Chinese data on loans, investments and industrial production.

Despite the up-and-down prices based on economic figures from China and the U.S, copper prices averaged $3.163/lb in September, down from $3.175/lb in August and $3.223/lb in July.

As usual, prices have been impacted by weaker-than-expected Chinese economic data and US dollar strength in recent days, though the outlook remains positive.

“As we approach the new industrial mating season the metals continue to exhibit healthy advances despite gloomy forecasts from some quarters,” says regular contributor Michael Turek, Head of the Metals Desk for NewEdge out of New York. “The gains anticipated here are being further fuelled by potential and actual supply shortages and disruptions – the latest of which is centered around the Philippines. While the shorts are feeing some discomfort we might expect further steady if unspectacular upside progress.”

According to Barclays Research demand will likely be underpinned in the second half of 2014 by China’s spending on its power grid, a top demand source for copper.

In the longer run, tight supply globally could lend support for copper prices despite China’s anemic demand. Barclays also points to supply disruptions in Indonesia, which has put bans on the export of unprocessed copper.

Copper to Shift into Deficit by 2016, 2017

With the scandal surrounding Chinese shadow lending earlier this year and a flurry of mergers and acquisitions this summer, the copper space has certainly seen some excitement this year. But now that calls for a surplus have been replaced with cries for a shortage, it can be difficult for investors to figure out what’s really going on with the red metal.

To get a little more insight into the copper market, Copper Investing News (CIN) caught up with Stefan Ioannou, mining analyst at Haywood Securities. In the interview below, Ioannou breaks down the effects of Chinese shadow lending, talks about what the current state of the market means for mining companies and gives his outlook for copper prices.

Overall, Ioannou sees copper sitting around $3.25 for the rest of the year, with a deficit pushing prices higher later in 2016 and into 2017.

CIN: In your view, how have copper prices performed so far this year? Were there any surprises for you?

SI: Year-to-date, the copper price has been in line with what we’ve been expecting. The average is $3.15, and it’s about $3.20 right now, so no major surprises.

I think the one thing that caught everyone a little off guard was the impact of Chinese shadow lending. It caused some volatility, especially early in the year when we saw copper drop below $3. It has since recovered, but that did cause a lot of uncertainty.

CIN: With that in mind, could you give our readers a bit of an overview of what happened in terms of Chinese shadow lending?

SI: Essentially what happened was that the Chinese were buying copper and keeping it in non-bonded warehouses, then using it as collateral to get low-cost loans to slip into higher-yielding investment vehicles. However, it became pretty apparent that there was some fraudulent activity going on — basically these guys were using the same block of physical copper as collateral on multiple loans.

A big concern was that with the fraudulent activity and the government tightening down on the whole situation, we were going to see those Chinese investors look for other means or other forms of collateral to do their financings with. That meant that all that copper in these non-bonded warehouses was potentially going to hit the market and flood it, at least for the short term.

CIN: That happened in the first half of the year — is it still affecting the copper market?

SI: Since then there have been a lot more stringent regulations put into place, but there is still some uncertainty lingering in the market. I think we’re through the worst of it, but the issue did cause copper to dip down to the $3 level earlier this year.

CIN: Thanks for clearing that up. Are there any other things investors should be watching to get cues on the copper market?

SI: In terms of things to watch in the copper space, the most transparent inventory is the London Metal Exchange (LME). Information on LME volumes is readily available, but keep in mind, the inventory is only one piece of about a six- or seven-piece pie. It does give a bit of an indication, but there’s also the COMEX, there’s the Shanghai, there are mine inventories, there’s recycling and then there are all the non-bonded stockpiles as well. Also, remember that LME inventories were falling notably as Chinese shadow lenders moved the metal into non-bonded warehouses. However, as noted earlier, this metal was not being physically consumed to make computers and refrigerators, but rather was being stored as collateral on other investments.

All that said, over the last couple of months we’ve been seeing that total exchanges such as the LME, Shanghai and COMEX are on the down. They are decreasing. Year-to-date, all three combined are actually down 49 percent, and that includes the LME being down year-to-date almost 60 percent. It was quite high to start the year off, but we’re getting down to levels that are relatively low. We’re talking five to six weeks of consumption versus much bigger numbers previously.

CIN: What about real demand from China? There’s been a lot of talk surrounding China buying copper to build cities that don’t seem to be inhabited. Is that a good thing for the copper market?

SI: The one issue with China, and not just for copper, but for anything, is that it’s a bit of a black box. That means getting reliable, consistent data is difficult from the outside, and that is a concern. China is consuming all these metals and commodities, and they have these massive growth plans, but is that a paper bag that’s going to fall apart at some point? Is there a glass ceiling? Time will tell, obviously.

If you start breaking it down to the population of the country, if even a small fraction of those people want to move into a western lifestyle — they want to live in cities and have iPhones and all that sort of thing — there’s a massive amount of consumption coming down the pipeline to support that.

It’s a big paradigm shift for China. It’s obviously a manufacturing center of the world, and right now with a lot of that manufacturing things get made there and sent elsewhere. At some point though, a greater proportion of China’s manufacturing will be consumed internally. The population figures underpinning this anticipated internal demand are obviously very significant and will in turn drive the country’s demand for copper and other commodities.

CIN: Just to talk a bit about copper supply and demand predictions overall this year, there have been calls for a surplus and lower overall prices. However, I’ve also seen predictions of the biggest deficit in seven years. How do investors navigate through that conflicting information? Who is right?

SI: A lot of it is global demand for the metal — and of course, when we say global, one of the biggest pieces of that global demand picture is China — and the encouraging thing there is China’s Purchasing Managers’ Index. It’s one small piece of data, but what we’ve seen over the past couple of months is that it is rising steadily. Assuming that trend keeps going, we are in a current surplus situation, and that will slowly get eroded away. The question is just how fast.

Realistically, I think we’re going to see copper probably trade in the range that it’s at right now for the next year or two. I think it will be early or mid-2016 before we really start to see the demand side take over the supply side on the curve.

CIN: What will be driving that shift?

SI: Well, there are a couple big things in the background driving that longer-term outlook. In the last few years we’ve seen a lot of major miners, the guys with the big, big projects, really shift focus to cost cutting at their existing operations as opposed to sinking capital into new development operations. That’s great for the bottom line today, but in terms of future supply, it definitely sets that back.

These are copper projects that still need to come online at some point and, if anything, they’ve all been delayed by a year or two — if not more — going forward. It’s like a self-fulfilling prophecy for the majors, because obviously cutting costs today increases their bottom line in the short term, and the effect of that is to drive up copper prices in the future because there just isn’t as much physical copper available.

CIN: So you’ve been seeing a lot of copper companies having difficulty getting their projects going?

SI: Yes. The mines that have been shelved are the ones that were still in the feasibility stage, where ground hasn’t actually been broken yet. We’ve seen a number of those projects get pushed back. With the ones that are in construction, a common theme in the mining space is cost overrun on the CAPEX side. It’s an unfortunate reality of the mining business and continues to cause grief for a lot of guys who are in the process of trying to build mines today.

CIN: How about with the junior or mid-tier companies? There’s been some M&A activity in those arenas recently.

SI: We’ve definitely seen companies position themselves opportunistically to take advantage of some of the larger or “better” development assets that are out there. For example, if you look at Rosemont, Augusta Resource’s (TSX:AZC) project, it’s a big copper mine and it’s quite robust in terms of what the feasibility study delivers. Obviously there’s a permitting challenge there, so I’d say Hudbay Minerals (TSX:HBM) is going into it with a very long-term view. It’s something they can acquire today for relatively cheap, and then as long as they’re not too aggressive on the timeline, I think they can make it dovetail with their existing operations.

The same can probably be said for First Quantum Minerals (TSX:FM) and its recent acquisition of Lumina Copper (TSXV:LCC). It’s a matter of getting your ducks in a row so that when copper prices are higher you’ve already got the project. You’re not paying a massive premium for them when copper is at $4. You’re getting them at a discount when copper is $3 or less. They’re taking advantage of sale prices right now.

Those are just a few examples. Keep in mind, there are also a number of big projects out there right now that are held by junior companies, and while they’ve done a lot of good exploration work and development work in terms of the engineering of these things, the next step is to finance. For a junior with a sub-$100-million market cap, trying to get over the hurdle of raising project financing to build a $1-, $2 or even $3-billion base metals project is next to impossible in these markets. And with the majors taking their own focus off some of these larger-scale development assets, it leaves a lot of these juniors high and dry.

CIN: That being said, what’s your overall prediction for the copper price?

SI: Again, realistically I see copper in that $3.25-a-pound range for this year, next year and into at least the first half of 2016, but as we hit that second half of 2016 and more so into 2017, 2018 there are some indications that we could start to see the market slip from surplus into deficit on the supply side. That’s going to obviously support copper prices higher. I don’t think seeing a four in front of the copper price is an unrealistic expectation from a medium-term perspective.

CIN: Are there any other factors we haven’t talked about that you see affecting the copper price?

SI: The one wildcard in the background is always unanticipated shutdowns at some of the big operations. We always see strikes pop out of nowhere, and with something like an Escondida having strike action, you turn off a couple percent of world production overnight; that can definitely cause short-term fluctuations in the copper price. It also isn’t common for analysts to add consideration for that type of event, so it’s something that’s not usually forecasted into a lot of numbers.

Not that Mount Polley is the world’s biggest copper mine, but if what happened with Imperial Metals (TSX:III) happened at a bigger mine, that could actually impact significant production. For example, the open-pit wall failure we saw at Bingham Canyon a couple of years ago comes to mind.

Unforeseen events aside, there is arguably room for the copper price to come down given that even the higher-cost producers are still generating profits at $3 copper. The copper price would probably have to drop below the $2.50 range before impacting existing production associated with the upper end of the copper cash cost curve.

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