Category Archives: Commodities


Get Ready For A Zinc Deficit

  • Zinc prices are already up by 50% this year and more growth is expected.
  • Mine closures and limited mine openings create a supply gap.
  • The World Bank estimates tight zinc markets for the foreseeable future.


Zinc is the fourth most used metal in the world. It is mostly used for steel galvanization – the process of corrosion-resistant zinc plating. Other uses include alloys such as brass, and dietary supplements.

The metal is typically mined in combination with copper, and similarly to copper, the main investing thesis behind zinc is that it is entering a supply deficit phase due to mine closures and increased demand.

This article is going to provide an overview of and outlook for the zinc market, an elaboration of the investment thesis and analysis of investment opportunities.

Zinc Market Overview

Due to global urbanization and development, zinc production has increased by 55% since 2000 and demand for the metal is expected to continue growing by a rate of 4% per annum. This constant demand growth is creating a zinc market deficit due to the fact that current zinc production cannot keep up with demand.

According to the International Lead and Zinc study group (ILZSG), mine production in 2016 is going to fall by 1.4%, total metal production that includes recycling will increase by 0.5%, while demand is expected to increase by 3.5%.

1 zinc 2016 estimate
Figure 1: Zinc is in a strong supply deficit. Source: ILZSG.

Supply was already lowered in 2015 as MMG removed about 350,000 tons of zinc from the market by closing its Century mine that was Australia’s largest open-cut zinc mine, and Vedanta Resources removed an average of 300,000 tons of zinc concentrate annually by closing its Lisheen mine in Ireland. Glencore has also cut back its zinc production by one third—or 500,000 tons—due to its high production costs.

As total mine production is forecasted to be 13,271 thousand tons of zinc in 2016, the closure of the two mines and Glencore’s cutback only removed about 8.5% of the global zinc supply. As there were no major zinc mine openings and there aren’t any in sight as it takes an average 15 years to develop a zinc mine, this resulted in a huge spike in zinc prices since the beginning of the year and lower London Metal Exchange (LME) zinc inventories.

2 figure zinc prices and LME stocks
Figure 2: Zinc prices and LME inventories. Source: World Bank.

As zinc moved into a supply deficit, LME inventories started to decline, and as supply got tight, prices shot up.

3 figure 12 months zinc price
Figure 3: Zinc prices in the last 12 months. Source: Witco.

The above represents an increase of 40% since December 2015 lows, but the outlook and average historical prices (figure 2) show that there is still plenty of room to grow.

The outlook for zinc is very positive from both independent and zinc dependent sources. ILZSG expects a further deepening of the zinc supply gap in 2016, and Teck Resources expects a continuation of the zinc supply deficit for at least 5 years.

4 figure up to 2020
Figure 4: Expected zinc supply deficit up to 2020. Source: Teck.

This is in accordance with the Word Bank and the International Monetary Fund expectations related to zinc prices.

5 figure expected prices
Figure 5: Expected zinc prices per ton. Source: World Bank.

The World Bank’s expected steady increase in zinc prices shows that there is a structural trend developing in the zinc market. But this doesn’t mean that the price will develop exactly like above. Short term periods of market tightening can result in large price increases, while risks like slower economic growth in China can negatively affect the price.

6 figure china zinc
Figure 6: China is the biggest consumer of zinc. Source: ILZSG.

Investment Opportunities

As the situation in global zinc markets is pretty straight forward and positive, an issue with zinc arises from the fact that it is difficult to find pure zinc investments as zinc is often a by-product in mining and mining corporations usually have other main resources. But a good alternative is the PowerShares DB Base Metals Fund that has a 33% exposure to zinc, with the remaining two thirds exposed to copper and aluminum. The copper exposure is also good as copper is expected to enter into a supply deficit by 2018.

For direct zinc stock exposure the important thing is to calculate the revenue percentage deriving from zinc in a company, assess the future outlook for other metals, and to see if production costs are below the cost curve.

7 cost curve
Figure 7: Zinc cost curve. Source: Teck Resources.

Low production costs enable a company to weather price declines and add extra profits when the cycle turns.


The conclusion is simple: zinc is going into a huge supply gap if global economic conditions stay stable. Most risks are related to the continuation of growth in China but this can be offset by India as it is entering a phase of high urbanization and infrastructure investments.

In relation to zinc investments, pure zinc miners can be found on the Canadian stock exchanges but as those are mostly young miners, their risks are not only related to zinc prices but also to the quality of their development projects and execution capacities. With more established miners the issue lies in their portfolio diversification. The best opportunities are to invest in ETFs with exposure to zinc.



Metal Madness: Commodity Boom and Bust Cycles

  • Metals have recovered a bit, but even miners are bearish now.
  • Forecasts are not inspiring for at least the next two years.
  • A lot of indicators suggest that there is another commodity boom cycle in the making as the global economy continues to grow and investments in mines decline.


Commodities had hit rock bottom this winter when iron ore prices went below $40, and alongside iron ore all other commodities except gold were in a slump. This slump in prices provided great returns to investors that had the guts to buy when most thought the world was over for miners. Iron ore prices have rebounded by more than 50% since their lows but are still far from their historical highs.

1 figure iron ore 112 months
Figure 1: Iron ore 12-month chart. Source: Index Mundi.

As similar patterns have affected other commodities, this article is going to provide indications as to whether the rebound is going to continue or if it is just a dead cat bounce.

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Figure 2: Bloomberg commodity index for the last 5 years. Source: Bloomberg.

Miners Are Not So Bullish Anymore

Miners had usually been bullish as they estimated that lower prices would push high cost producers out of the market, and with less competition, allow more profits for the ones that survive. But the strategy did not work that well, nor that fast.

According to the second global iron exporter in the world, Rio Tinto (NYSE: RIO), the rebound in iron ore prices is not sustainable as more production is coming online and will offset improving demand from China. RIO’s CEO is even warning investors that iron prices will remain volatile.

The recovery in iron prices was influenced by strong demand from China that produced a record high of steel in March and will probably increase its production in April and May. This is good news, but the increase in steel prices and iron ore prices brought to the rapid reopening of capacity that had been shut or suspended that will soon put downward pressure on steel and iron ore prices, again.

The CEO of Antofagasta, a major copper producer, Mr. Arriagada recently announced that copper prices have recovered but still face pressures and are likely to remain subdued for at least another two years as surpluses are expected in 2016 and 2017.

In the Aluminum sector, the outlook is also bearish for 2016 and not much brighter for the next 5 years.

3 figure IMF forecast
Figure 3: International Monetary Fund Aluminum Forecast. Source: Knoema.

An indication of how bad this forecast is comes from the fact that Alcoa (NYSE: AA) is not profitable at the above prices as it breaks even at an aluminum price of around $1,800 per ton.

The situation with coal isn’t any better. The US Energy and Information Administration (EIA) forecasts continued oversupply, even with decreased production.

4 figure eia coal supply and demand
Figure 4: EIA coal supply and demand outlook. Source: EIA.

With prices continuing to decline, and omnipresent oversupply, the coal industry will see even rougher times ahead.

Silver is also not in a good situation as its price rebounded 15% from its bottom in December 2015, but is at the same level as it was exactly a year ago and still 63% down from its 2011 high.

5 figure silver prices
Figure 5: Silver prices since 2011. Source: .

The outlook for silver isn’t that positive as falling silver intensifies in electronic and photovoltaic sectors, and declining trends in photographic applications are contributing to overall lower consumption.

6 figure silver forecast
Figure 6: Silver outlook. Source: World Bank.

The story with gold is different than the above mentioned metals as gold is considered a safe haven in difficult economic times. As difficult economic times seem to be over and the likelihood of the FED increasing interest rates yield strengthens, baring assets will be favored and gold should decline. Physical demand for gold has been weak lately as the two largest gold consuming countries, India and China, lowered their demand. In India, an excise tax of 1% was announced on gold and many jewelers went on strike, while in China demand is weaker due to a slowing economy. As the FED has become more hawkish on interest rate increases, gold has lost 5.9%.

Resource Development in an Era of Cheap Commodities

Commodities peaked in 2011 and have been falling ever since. What happened is that with high prices spurred by growing demand from China, many new projects were developed as they were considered profitable with the high prices.

At the moment there is an opposite trend as many resource development projects are put on hold, showing exactly how mining commodities is a purely cyclical industry. With agriculture, higher prices quickly prompt farmers to plant more of that commodity and cycles are shorter. With mining, it is very difficult to just increase production because it is a very long an expensive process to find and develop a mine, and all the low hanging fruit has already been mined.

7 figure copper and gold lead times
Figure 7: Distribution of discovery to production time. Source: Pumpkin Hollow Project.

As the development of gold or copper mines takes at least 5 years, with 12 years being the most common for copper and with some taking more than 60 years, with the current postponing of investments in research development we might soon witness another commodity super cycle as we have witnessed in the first decade of this century.


Low commodity prices have several influences. It’s not that strange that Europe can’t reach any inflation let alone the 2% targeted level, and that the FED is also struggling to reach the target no matter the low interest rates or quantitative easing. As everything that is produced begins with commodities, this is also where the pricing starts. As soon as commodities pick up, inflation will also soon follow, but according to forecasts that should not happen in the next year or two. As stock markets always anticipate what is going on in the market, investors wanting to take advantage of the future commodity boom cycle should position themselves before it is too late.

Low commodity prices also raise concerns about the ability of commodity-exporting emerging markets and developing economies to withstand shocks in the global economy, as their main source of liquidity is exporting commodities. But those economies would benefit from increased commodity prices and markets would soon grow.

Lower investments in research and development and a heathy global projected economic growth of 3.4% by the International Monetary Fund will eventually result in a boom for commodities. When that will happen is unfortunately beyond the scope of this article, but at least it is clear that it will happen.



Is There Equilibrium in Oil?

  • Production costs are below current prices and reserves are constantly growing.
  • OPEC’s rosy forecast of $70 a barrel in 2020 is based on a model excluding any disruptions from electric engines or renewable technology developments.
  • Demand in developed countries is declining and the trend might spill over to developing countries.


Oil prices above $100 a barrel seem impossible but they were a common thing just two years ago. 2014 was the worst year for oil as it tumbled more than 50% from above $100 to below $50 a barrel. In January 2016, oil reached lows not seen since 2001 and 9/11 with prices below $30. The current price of oil quickly rebounded from those lows and is currently around $45 a barrel.

1 figure oil prices
Figure 1: Oil prices 10-year chart. Source: Nasdaq.

As oil is a commodity, its price is formed by the levels of supply and demand for it and future expectations. This article is going to analyze the oil market and look for an equilibrium price in order to make oil related investments easier to assess.

Oil Supply, Demand and Stock Levels

The first thing to look at is the US stocks of crude oil.

2 figure stock piles
Figure 2: Weekly ending stocks of crude oil and petroleum products. Source: U.S. Energy Information Administration.

The current stocks are at an historically high level and the recent uptrend is easily correlated with the slump in oil prices. A look at supply and demand is necessary to see if the stock levels are just going to grow higher or there is a possibility for further increases in oil prices.

Oil Supply and Demand

A look at oil supply has to be global as the costs of shipping oil around the globe are also at historic lows. World oil supply has been surging as new technologies like shale oil extraction became a profitable investment with high oil prices.

3 figure world oil supply
Figure 3: World oil supply. Source: International Energy Agency.

Global oil supply increased by more by 5.5% from 2013 and only started to decrease in Q1 2016 as high cost producers are slowly forced out of the market. But, demand is still below supply as producers are hoping for a rebound in oil prices and therefore keep production alive.

4 figure world oil demand
Figure 4: World oil demand. Source: International Energy Agency.

The daily average production oversupply is consistently around 0.5 and 1 million barrels. For a sustainable rebound in oil prices that daily oversupply has to vanish.

5 figure oil demand supply
Figure 5: Oil supply and demand. Source: Yardeni Research.

A look at producing costs, resources and potential output will give us an answer to the long term oil outlook.

Production Costs and Potential Output

The average production costs per country show that production costs are far below the current oil price except for the UK.

6 figure oil production costs
Figure 6: Oil production costs by country. Source: The Wall Street Journal.

Usually production costs are the ones that set a bottom to commodity prices and therefore it seems from the above figure that lower prices are more probable than higher prices.

Reserves and Output

Currently the global proved oil reserves amount to 1,700.1 billion barrels, which is sufficient to meet 52.5 years of global production. Even with increased oil production, oil reserves have increased by 24% over the past decade. Oil reserves to production ratios show that there is plenty of new potential output if prices increase which can easily bring prices down again.

7 reserves to production
Figure 7: Reserves to production ratios. Source: BP.

High reserves and low production costs are not the only trouble for oil producers, maybe the most important one is that as the world develops less oil is needed due to higher environmental standards, improved energy efficiency and increased support for renewable energy. The decrease in demand from OECD countries shows how important and dangerous for oil this is and can be.

8 figure oil OECD demand
Figure 8: Demand for oil in OECD and developed countries. Source: Yardeni Research.

Oil demand in developed countries peaked in 2006 and is not growing any more. With China slowing down and fuel efficient and electric technologies quickly spilling over globally, the outlook for oil is not bright. The OPEC (Organization of the Petroleum Exporting Countries) forecasts oil prices of $70 a barrel in 2020, $123 by 2030 and $160 by 2040 including inflation. These forecasts have to be taken with a grain of salt as oil producers tend to be overoptimistic creating forecasts based on models that use current data and trends while excluding the influence of disrupting technologies and cost saving oil exploitation methods and keeping reserve levels fixed. Based on current trends OPEC forecasts oil demand growth of only 0.7% per year up to 2040. Similar forecasts were made in 2009 when Goldman Sachs forecasted oil prices of $200 a barrel based on the continuation of previous trends. Therefore, the OPEC scenario should be used as the best case long term scenario.


Oil reminds of phone lines: once essential and now almost obsolete. Investors always have to be aware of secular trends and assess their risks properly. Oil prices and oil related investments are going to be volatile for sure, but the low production costs, high reserves and new technologies do not create a positive outlook. As supply can easily cover demand, no spikes in demand are forecasted as the world is turning to cleaner and renewable energy sources. Oil exploitation is in a declining trend and stocks should be considered only as cash cows. High and expensive exploration projects like Royal Dutch Shell’s Arctic explorations should be avoided as only low cost producers with high reserves should be considered. As the low cost producers are mostly state-owned, finding the best investment necessitates proper understanding of the oil sector and due diligence. As a general investment, oil currently does not show any long term positive catalysts. Short term spikes are always possible.



Is It a Good Idea to Invest in Lithium?

  • Tesla announced building 500,000 cars in 2018 and purchasing the complete current global lithium supply per year.
  • Lithium is not scarce and could easily get oversupplied even with demand growing.
  • Other technologies, like vanadium batteries, will always present a threat to lithium.


On May 5, Tesla’s (NASDAQ: TSLA) Chairman and CEO Elon Musk announced that TSLA intends to produce half a million cars in 2018. Apart from the craze currently surrounding TSLA, the trend towards electric vehicles is undeniable. An option that does not imply direct investments into electric cars manufacturing companies is an investment in lithium related investments as lithium is the most important material for battery production. This article is going to elaborate further on the investing possibilities, risks and rewards of the lithium option.


Lithium is a soft, silver-white metal with lots of industrial applications including heat-resistant glass and ceramics, lithium grease lubricants, flux additives for iron, steel and aluminum production and most importantly, lithium batteries and lithium-ion batteries. The demand for lithium batteries has fueled an immense increase in lithium prices in the last 12 months.

figure 1 lithium prices
Figure 1: Lithium related products price movements in the last 360 days – China. Source: Asian Metal.

Surprisingly, increased lithium prices had an opposite effect on the Lithium ETF. As more and more projects are announced for lithium mining, existing producers face lots of competition and the above spike is considered temporary.

figure 2 lithium etf
Figure 2: Lithium ETF. Source: Yahoo Finance.

The Global X Lithium ETF (NYSEArca: LIT) has performed terribly in the last 5 years. It fell from a value of above $46 in 2011 to the current $22.63. The ETF consists of the world’s biggest Lithium miners and lithium related companies like TSLA.

figure 3 lithium holdings
Figure 3: Lithium ETF top 10 holdings. Source: Global X.

The problem is that all of the top holdings that are lithium miners have seen their stock price plummet since 2011 as none of those companies is a pure lithium miner. FMC Corporation gets 70% of revenue from the agrochemical market and its primary market is Brazil, while SQM—which has one third of the world’s lithium reserves—receives only 11% of its revenue from Lithium. Therefore, even if the ETF is called the Global X Lithium it is not a pure lithium mining play. Unfortunately, such an investment does not exist, except for small lithium focused miners. Also, lithium is not traded on an exchange like it is the case with other commodities like gold or copper. Therefore, finding a specific lithium investment is a challenge in itself.

A lithium focused small cap investing strategy requires high specialization and lot of due diligence. Never forget the saying that a miner is usually a liar standing next to a hole in the ground.

Lithium Potential Supply

The main reason behind the weak lithium and lithium related stocks’ weak long term performance is that lithium is not a scarce metal. Even if Goldman Sachs is estimating lithium demand to triple by 2025 to 570,000 tons, apart from short term occurrences, there should not be a supply gap for lithium because it is a highly available metal and higher demand would only allow large mining projects to become feasible and lower the price. An example is Lithium X, a small lithium miner that has a concession in Clayton Valley, Nevada, with resources of 2.8 million tons, five times the 2025 estimated demand.

figure 4 lithium valley nevada
Figure 4: Clayton Valley Nevada. Source: Lithium X.

The map clearly shows how other miners are also researching the area and will probably add to the supply in the longer term.

Another example is the Chilean company SQM (NYSE: SQM) that has produced only 38,700 metric tons of lithium carbonate in 2015 even if their capacity at this moment is 48,000 metric tons.

figure 5 sqm potential and output
Figure 5: SQM’s lithium production. Source: SQM.

Global miner BHP Billition’s CEO Andrew Mackenzie said that the lithium market is pretty small and it is unlikely that BHP will tap into it.

Risks Related to Lithium

Apart from the potential and quickly reachable oversupply, there are other risks related to lithium. As technology quickly evolves, it would not be surprising to see lithium replaced by other materials in batteries. Vanadium batteries are one example: the current advantages of vanadium are that it can be recharged more than 200,000 times while lithium batteries only about 7,000 times. On the other hand, vanadium batteries take much more space but there is always the risk that a new finding or technology might be around the corner and remove lithium from the throne.


Lithium fulfills only partly the criteria necessary for a low-risk / high-reward commodity investment. Demand is certain to increase but supply can also increase very quickly. There is no direct lithium investment except for small miners and those are always carrying high amounts of risk. The big global lithium producers have only part of their revenue deriving from lithium and have plenty of untapped mining potential in the case lithium demand increases.

Unrelated to the lithium issue but a good general example for investing in ETFs is the Lithium ETF mentioned above. As it consists of miners that receive only part of their revenue from lithium mining and companies that only use lithium, it shows how investors should do proper due diligence before investing in any ETF as the name might be misleading as it is the case for the Global X Lithium ETF.



Investment Opportunities in Iron Ore

  • Iron ore as a commodity faces long term oversupply.
  • The shift to a service oriented economy lowers Chinese steel demand growth.
  • Short term euphoria makes iron ore and related assets great for trading.


Iron ore is the world’s most mined and commonly used metal as 98% of it is used to make steel. As steel is mostly used for infrastructure and building it is not surprising that China is the world’s biggest consumer of iron. China produces 50% of the world’s steel output and 47% of the world’s iron ore.

Figure 1: Steel consumption in China and the world. Source: LKAB.

Therefore, China is the main factor for iron ore pricing. As Chinese demand for steel grew so did the price of iron ore. Increased iron ore prices brought increased investments in mining, and currently supply is higher than demand. In such a situation, a decline in prices is unavoidable and the decline in iron ore prices has been unstoppable for the last 5 years. From $180 per ton in 2011, the price of iron ore has eroded to the current price of around $60, but also reached prices below $40 in December 2015.

2 figure iron prices

Figure 2: Long term iron ore prices. Source: Iron Ore: Facts.

Unfortunately for iron ore miners, the outlook is not bright. The World Steel Association (WSA) is forecasting a decrease in steel demand in 2016 of 0.8% and just a slight increase of 0.4% in 2017. Also, unlike other commodities like copper, the world’s iron ore reserves seem enough for many more years of increased consumption. Estimated global reserves are 170 billion tons while current global consumption is 3.2 billion tons per year.

With low prices, high iron ore availability and lower demand for steel, logic would have miners lowering output in order to realign supply with demand to increase iron ore prices. But the world’s biggest miners have chosen a different way, one that has also strongly influenced the above price decline.

The Iron Ore Increased Supply Strategy

The strategy in the iron ore mining sector is one of increased supply in order to force high-cost supply to exit the market. The goal of such a strategy is to increase market share and reach higher profits with lower margins on bigger volumes. The world’s largest miners—Rio Tinto (NYSE: RIO), BHP Billiton (NYSE: BHP), Fortescue and Vale (NYSE: VALE)—are all increasing production. RIO and BHP require iron ore prices at around $25 to break even while Fortescue and VALE require prices to be around $40. 25% of global iron ore production has costs above the current spot price and most of the high cost producers are in China. Therefore, the big global miners hope to reach maximum profits by increasing production and completely conquering global markets.

3 figure cost curve

Figure 3: Iron ore cost curve. Source: Metalycs via

The strategy is not yet showing positive signs as all the above mentioned miners have reported losses (RIO and VALE) or minimal profits (BHP and Fortescue) in the last 4 quarters. In order to see if the strategy is going to pay off in the long term, it is necessary to look at the forecasts for iron ore.


In the short term iron ore prices have quickly recovered from this winter’s lows and are currently boosted by increased building expectations in China. But, Goldman Sachs is describing this increase in prices as temporary because there was no shift in raw-material fundamentals and expects iron ore prices to return to $35 per ton soon. Also, RIO and BHP have warned that prices will come down again.

A mid-term outlook shows that iron ore is bound to stay at low levels as the trade balance outlook remains highly positive through 2020.

4 figure trade balance

Figure 4: Iron ore China trade balance (price is from begin 2015 and has to be adjusted lower). Source: ABM Brasil.

The World Bank estimates that iron ore prices will be around $50 per ton for the next five years as the increase in low cost supply is much larger than the closures of high cost mines.

In the long term, iron ore prices are completely dependent on steel demand and steel demand is not expected to grow at the same rates it used to grow in the last 15 years.

5 figure steel demand forecast

Figure 5: Steel demand forecast. Source: ABM Brasil.

As a country becomes more developed the infrastructure and building necessities become more service oriented and therefore demand for steel diminishes. A case for steel would logically be India as the successor of China in growth and infrastructure building, but it is forecasted that India will mostly be self-sufficient in its steel production.

As low commodity prices limit new investments and commodities are cyclical, somewhere down the line another surge in iron ore prices can be expected. But, according to Wood Mackenzie such a situation should only emerge after 2025 or even later, as current capacity is enough to cover demand and increased production will probably lead to a long term oversupply.

7 figure supply

Figure 6: Supply comfortably exceeds demand for the next two decades. Source: Wood Mackenzie.


Considering everything above, iron ore seems a tricky asset. High availability excludes a copper scenario where it is known that mine grades are bound to be lower in the future. Long term oversupply and a shift in the Chinese economy from a manufacturing and heavy infrastructure investing one to a more service oriented one does not make a strong case for iron. But, iron ore prices have fallen more than 75% from their 2011 peak so there should be opportunities to make profits. Perhaps iron ore should be left to traders that have the stomach to weather huge swings and the knowledge to seize the volatility as the price is influenced by oversupply in the long term but also by short term euphoria like the in the last two months based on increased lending and hopes of a return to previous levels in Chinese infrastructure growth.



Copper as an Investing Opportunity

  • Copper has declined due to a strong dollar, increased production and a slowdown in China.
  • In the long term a supply deficit is expected as mining grades are constantly getting lower and demand is steadily growing.


Commodities in general have been in a slump for the last 5 years; the Dow Jones Commodity Index peaked exactly 5 years ago on April 26 2011. High 2011 commodity prices induced new investments that—combined with low interest rates—made it easier to finance new projects, eventually increasing supply. With limited growth in demand the inevitable result was a contraction in prices.

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Figure 1: DOW Jones Commodity Index. Source: S&P Dow Jones Indices.

But, commodities are known to be a cyclical business. The current low prices put off new investments and developments that limits further increases in supply and should bring to a commodity upturn cycle.

As commodity prices are mostly influenced by demand in relation to the business cycle, supply and production constraints, political issues, the value of the US dollar and investments funds speculation, those are the factors one should focus on when researching a commodity to invest in. This article will take a deeper look at how copper fits into the above picture.


Copper’s malleability, strength and conductivity make it useful in a range of building and electrical applications, and as it is found in nearly every home and vehicle, copper is the third most mined metal in the world.

538 2 figure copper prices

Figure 2: Copper prices. Source: Nasdaq.

Copper prices had been slowly falling since 2011 and further fell in 2015.

Copper Supply

One of the interesting things about copper is that many expect a looming copper supply crunch due to the fact that demand is constantly growing alongside global GDP growth, but the copper mining grades are getting lower and at current prices many of the new projects in development are not feasible.

The International Copper Study Group (ICSG) released its copper forecast for 2016/2017 back in March. World mine production is expected to increase by around 1.5% in 2016, already much lower than the 3.5% growth experienced in 2015 due to production cuts in the Democratic Republic of Congo and mine closures in Chile. In 2017 growth is expected to be 2.3% fueled by the expansion of existing projects and new mine developments.

In the longer term, there are several issues expected to limit copper supply. The first issue is that it takes more and more time from a discovery to actual production due to geological, environmental and political challenges. An example of that is the Oyu Tolgoi mine in Mongolia owned by Turquoise Hill (NYSE:TRQ). The site was discovered in 2001, first open pit mining began only in 2013 and underground mining that contains the main resources is expected to begin only in 2021, political and financing conditions permitting.

538 figure 3 years to production

Figure 3: Number of years from discovery to production. Source:

In total the average number of years from discovery to production has gone from an average of 7 years two decades ago to the current average of 20 years as new feasible mining opportunities are mostly found in difficult environments, like Mongolia for example.

The second issue is low mining grades. Due to the fact that the low fruit is usually picked first in the longer term copper is expected to become much scarce. The lower the grade of copper the more ore has to be mined in order to produce the same amount of copper. More mining means higher costs.

538 4 declining grades

Figure 4: Copper mining and reserve grades. Source:

Back to our previous example, the Oyu Tolgoi mine, which is the main copper development project for Rio Tinto (NYSE:RIO), as RIO owns 51% of TRQ, it has a reserve grade of 0.85%. Escondida, the world’s largest copper mine, owned by BHP Billiton (NYSE:BHP) is also experiencing lower grades. BHP anticipates 27% lower grades in 2017.

Lower mining grades and longer lead times should strongly effect copper supply.

Demand for Copper

Copper is used in various industries and the diversification provides a margin of safety in relation to potential disruptions in copper demand.

538 5 figure copper consumption

Figure 5: Copper consumption per sector. Source: London Metal Exchange.

Demand for copper is strongly related to global GDP as population growth and development leads to housing growth and more vehicles and technology being bought. Albeit with ups and downs, the global economy is expected to continue growing and therefore the demand for copper is also expected to grow. When this is combined with the previous supply analysis the following estimation is the result.

538 6 supply deficit

Figure 6: Copper supply deficit. Source:

Lower mining grades and higher demand could create a 10 million ton supply deficit in the long term.

In the short term demand disruption might result from a slowdown in Chinese economic growth as China is responsible for about 40% of global copper consumption. The current slowdown in China is the main cause for copper falling below $2.00 per lb. A continuation in Chinese growth and global development should remove fears around copper.

Another interesting variable is the increase in the number of produced electrical vehicles and a shift towards cleaner energy sources. The production of an electrical car necessities three times more copper than a gasoline powered car. Also, an average of 3.6 tons of copper is used to create a megawatt of wind power capacity.

Copper and the Dollar

Copper prices are expressed in US dollars and therefore copper prices are strongly influenced by US dollar movements.

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Figure 7: Copper vs. the US dollar. Source: Stapleford.

The long term 0.8 negative correlation between copper and the US dollar means that 80% of the changes in copper prices can be explained by changes in the US dollar. Therefore, copper could be also considered as a strong dollar hedge.


The supply deficit should be offset by increased prices that could lead to increased production but at that point the gains from investing in copper should already have been made. Wood Mackenzie estimates that the global supply deficit for copper should amount to 10 million tons by 2028. By looking at the current production cost curve for copper such a supply deficit would trigger an immense boom in prices.

538 8 cost curve

Figure 8: Copper cost curve. Source: SNL Metals & Mining.

With copper demand expected to grow constantly and limited low cost production, the above cost curve indicates that a supply deficit could easily bring to copper prices of $4.00 per pound or higher. Any increase in copper prices above the cash costs is pure profit for the miners and therefore a copper supply deficit could create extraordinary returns.

The best way to invest in copper would be to find a miner that has low debt and low production costs so that it can survive the current slump and a long mine life in order to fully grasp potential future supply deficits. If you are less inclined to investing directly into a miner, a good option is copper ETFs.


A Coal Perspective on Commodities

  • Coal has seen lots of bankruptcies but companies continue to produce and the price remains low.
  • Iron ore provides better investing opportunities and a better demand scenario.
  • Low cost and low debt producers with increasing demand should be the best risk/reward investments.


Yesterday’s newsletter mentioned that there might be opportunities in the commodities markets. Today’s letter is going to elaborate on why the coal mining industry is seeing many bankruptcies and extract important insights in order to enable finding opportunities in other commodities that minimize risks and maximize returns.

Coal Mining Industry

If commodities prices go down, as it is the case for coal, slowly but surely, some of the companies engaged in the production of the specific commodity are bound to fail. As the below figure shows, the decline in coal prices is not an extreme case seeing that the price decline from the 2010 high is about 50%.

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Figure 1: Thermal coal price from 2001. Source: InfoMine.

Oil (65%), copper (53%), iron (72%) and natural gas (62%) prices have all declined more than coal prices from their highs but coal miners are the ones having the most difficult times. In January Arch Coal Inc (NYSE:ACI) filed for bankruptcy and last week Peabody Energy Corporation (NYSE:BTU) did the same increasing the already long list with Walter Energy, Alpha Natural and Patriot Coal that filed for bankruptcy last year. If we would add Cloud Peak Energy (NYSE: CLD) to the above list, we would have more than 50% of US coal production bankrupted. The high number of bankruptcies in coal implies that commodities do not always rebound from a downturn cycle as most investors and managers expect and that down cycles can last longer than liquidity available to companies. Other things that are not helping coal miners are environmental pressures and low gas prices that are lowering domestic and international demand. Apart for slowing demand, another factor that influenced the above mentioned bankruptcies was chronic indebtedness. BTU had 69% of assets financed by debt, CLD 67% and ACI 65% back in 2011 when things still looked good for coal miners. With the bad sentiment, debt became more difficult to refinance, impairment charges become imminent and declining margins brought to the above mentioned bankruptcies.

Another crucial factor for miners and other commodities producers is the cash cost in relation to the average selling price.

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Figure 2: Coal production costs. Source: Martson.

As US production is the most expensive, combined with the declining demand, high debt the large number of companies bankrupt or close to bankruptcy should not be a big surprise. But all the data above should give a clear indication of what and where to look for in order to find over performing opportunities in the beaten commodities world.

What to look for?

Now that the things to be careful about are known let us see if there are better commodities markets that allow grasping the opportunities that a downturn commodity cycle brings. The coal case brings to the conclusion that before investing in miners or other commodities producers, investors should look at:

  • The supply/demand structure of the commodity. Declining demand with unrestrained supply leads to ugly scenarios.
  • High debt levels combined with cycle downturns make refinancing very difficult and lead to bankruptcies.
  • The lower the cash cost of producing the commodity the more time the company has to weather a cycle downturn.


Oil might experience a coal like scenario if electric cars become able to weaken the increasing demand for liquid fuels. For now, the general expectation is that oil production will grow at a slower pace than demand seeing the lower oil prices.

Figure 3: World Liquid Fuels Production and Consumption Balance. Source: EIA.

A look at the production cost curve shows where to look for survivors if the slump in oil prices continues.
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Figure 4: Oil production cost curve.

The above figure shows that the lowest cost producers are mostly state owned companies and western world corporations have lower margins. This limits the investing potential and increases the risks as the lowest cost producers are not investable. On the other hand, with the ease of adding production in relation to increases in oil prices it can be estimated that the price of oil and thus also oil stocks will be volatile. Investors should always keep in mind the possible coal scenario due to the potential decline in demand influenced by electric vehicles.

Iron Ore

Iron ore is a commodity that is strongly related to steel production and steel production is strongly related to World GDP growth. As World GDP growth is strongly correlated to demographics most long term analyses show that the global economy will grow at about 3% in the long term as global population is expected to reach 9.5 billion in 2050. This growth should be reflected in demand for steel and consequently demand for iron. The cost production curve is more favorable for investors as the lowest cost producers are corporations and not state owned companies like for oil.

Figure 5: Iron ore cost production curve. Source:

The biggest producers like Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP), Fortescue (ASX:FMG) and Vale (NYSE:VALE) have the lowest production costs and are trying to eradicate the higher cost producers by keeping supply higher than demand.

Figure 6: Supply and demand for iron ore. Source: LKAB.

The supply is just marginally higher than the demand but by looking at the above cost curve (figure 5) any production shut downs from the more expensive producers could quickly erase the current supply glut.

A look at the debt ratios from the above mentioned iron ore producers shows that RIO has 59% of assets financed with debt, FMG 65%, VALE 62% and BHP is the best with only 48%. A deeper investigation before investing is necessary here as most of the above companies are involved in more commodities and not just iron ore.


The combination of low cost production, low debt, demand growth for the product and a compelling price is surely one that is hard to find. But seeing that commodities prices have fallen more than anyone expected there might be opportunities created by market panic. Goldman Sachs, notorious for its bullish oil price forecasts of $200 per barrel for 2009 and $100 for 2015 that ended with oil prices down to $40 in 2009 and $30 in 2015 is a perfect example how experts can be dead wrong. Wrong bearish forecasts by experts should be the ones that create the biggest opportunities for investing in commodities.

One final warning, the interesting thing with coal is that even if the biggest players declared bankruptcy, they did not stop producing. This trashes most managers’ and Saudi Arabia’s thesis that the downturn will end when companies start failing, because even if companies go bankrupt they will continue to produce as long as production costs are lower than the market price.  All a bankruptcy does is shift ownership of the company to the debt holders and continues to depress the commodity price, since these bankrupt companies do not immediately stop producing.  This clearly explains why oil fell from above $100 to $30 per barrel and has had a difficult time recovering.  As long as a company can produce at a cost lower than the market price, it will continue doing so. Therefore certain commodity prices could remain low for an extended period of time, which strengthens the thesis that the low cost and low debt producers are the best risk/reward investments, when acquired at a reasonable price.