Category Archives: Copper

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Commodities: Stick To The Fundamentals, Beware Of Speculation


  • Oil prices are increasing the number of rigs, putting pressure on prices.
  • Soros sold his gold, should you?
  • Iron ore is hot, but waiting until winter might provide better purchasing opportunities.

Introduction

Yesterday we discussed how Treasury Inflation-Protection Securities (or TIPS) are a great protection during times of inflation. Today we are going to take a deeper look into another great inflationary protection, commodities.

The general feeling is that commodities have surged since January, but there is a high level of divergence. This divergence in commodity price movements is due to speculation in some commodities and fundamental reasons in others.

Situation – Oil

Oil is currently trading at $46 per barrel which is 75% higher than it was at its low six months ago.

figure 1 oil prices
Figure 1: Oil prices. Source: Bloomberg.

The 75% price jump in oil is a clear indication of price speculation in oil markets because the demand is stable and well known. Speculators include the whole chain, from producers to retailers and future traders who can trade high quantities on margin. In such an environment, the only option is to make an educated guess about the long-term fundamental oil price and trade around it. As Russia and Saudi Arabia are in talks to stabilize the oil market, we could see the market push through year highs, but higher prices call for more global production. As oil prices stabilized above $40, the number of U.S. rigs increased for seven consecutive weeks and the global rig count also increased in July. More rigs mean more supply and further pressure on oil prices.

Investors should be careful with oil, production is very flexible and much of it is low cost which disables a higher level price stabilization. Therefore, oil is a pure trading play with fundamentals easily influenced by speculation.

Situation – Metals

As we discussed gold yesterday while discussing traditional safe haven assets, today we are going to focus on iron ore, copper, zinc and aluminum.

An additional warning for those long gold, George Soros, the legendary hedge fund manager that opened a $263 million position in Barrick Gold in Q1 has cashed out in Q2. Be careful not to get burned on gold as smart money is slowly leaving the playing field.

Iron Ore

Iron ore has had a wild ride this year, but its supply is much less flexible than oil and divergence from fundamentals can be easier to grasp.

figure 2 iron ore
Figure 2: Iron ore prices. Source: Bloomberg.

As iron ore is more predictable than oil, Morgan Stanley sees seasonal weakness ahead, increased supply due to the VALE S11D project, and suggests that prices might fall back to $40 again. Those dips are excellent opportunities to open a position in iron ore miners as when iron ore prices are low, their share prices also decline. By looking at the lowest cost producers, share price is the main risk factor as in the long run, big, low cost miners are unavoidable for global development. Companies to look at are Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE) and Glencore (GLNCY), but for lower risk it might be better to wait for winter.

Aluminum & Copper

Aluminum is only up 8% year-to-date, and copper is only up 3%. Both metals are a clear example of how commodities diverge. This divergence is what creates opportunity because lower prices tend to eliminate high cost production, limiting supply and pushing prices up again. The current price stability for aluminum and copper, and price increases for precious metals and iron, suggests that the 5-year commodity bear market has come to an end and things should slowly turn as we begin to run into supply deficits due to lower investments.

Aluminum and copper are closely related to global economic growth. An good aluminum play is Alcoa Inc. (AA), while with copper it’s good to look at the lowest cost producers.

figure 3 copper costs
Figure 3: Copper production costs. Source: Southern Copper Corporation (SCCO).

The production cost for the stock pick detailed in The Copper Goldmine—a report I wrote earlier this year, along with an update, that was sent to subscribers last Friday—was $0.92 per copper pound in Q2 2016, and is expected to be $0.52 for the company’s future copper project putting it among the lowest quintile in terms of production costs. To download this report, click here.

Zinc

Zinc is the superstar metal of the year. It has increased by more than 50% year-to-date and is expected to increase more due to the inevitable supply gap forming. More about the zinc supply gap here.

In addition to our above mentioned stock pick—which is transitioning from a mostly copper producer to a mostly zinc producer in 2017,—another good option to be exposed to zinc, copper and aluminum is the PowerShares DB Base Metals Fund (DBB) with equal weights for zinc, copper and aluminum.

Conclusion

Commodities seem to have reached a bottom, but global economic turmoil or China slowing down might ignite speculators to short metals on margin and put severe downward pressure on prices. Therefore, any commodity related investment has to be done with the notion in mind that 50% of it can quickly be lost.

On the other hand, the world cannot live without commodities and therefore it’s a good idea to be exposed to such an investment, especially to miners as their prices increase exponentially if commodity prices increase due to their fixed costs. Production costs are always the main factor in assessing how much can be lost when investing in commodities.

A good strategy with commodities at this point in the commodity cycle is to average down if commodities experience further declines and then ride in full the eventual upside. The upside is certain as global demand for commodities is expected to grow as a result of increasing demand from developing countries.

To sum things up, commodities are at or near their bottom. The upside impetuses to be aware of are growing global demand, limited supply and potential inflation, while downside risks come from an eventual slowdown in China or a global recession.

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Incredible Investing Opportunity & Free Report


In lieu of an article from Sven Carlin, today we wanted to send Investiv Daily subscribers a ‘Thank You’ in the form of a free report and a special bonus ($49 value).

The Copper Goldmine was written by Sven earlier this year. The report details one particular small cap mining stock that we felt was a great buy, ready to make big gains. Included in this report is an in-depth overview of the company, an analysis of their fundamentals, a detailed look into the market for the primary metals this company mines (copper and zinc), and an explanation on why this company is uniquely positioned to make incredible new highs.

Additionally, we’ve included a special bonus report that takes a look at where the small cap miner discussed in The Copper Goldmine is now—we’ll give you a clue, it has been just over 6 months since the initial report was published and this stock is doing very well—and why it’s still a great buy today.

We hope you enjoy these valuable reports, and we hope that you, like us, look forward to reading Sven’s analyses on the market in each day’s Investiv Daily.

To download your copy of The Copper Goldmine, click here, and click here to download the bonus update report.

Sincerely,

Kristina Keene
Editor, Investiv Daily

 

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Will A Bet On Commodities Pay Now?


  • Iron ore prices are falling as supply continues to grow, while copper and zinc prices show signs of supply gaps forming.
  • Low exploration and discoveries indicate that metals will be winners again in the future.
  • The possibility of future inflation increases the appeal of commodities.

Introduction

Diversification is the ultimate protection against various economic factors, in recessions you might want to hold gold or treasuries, in inflationary times you want to be long stocks and commodities. Therefore it is very important to always know what is happening in each potential diversification sector.

Three weeks ago we discussed how aluminum is a bet on global transportation and while a supply gap is not the issue, productions costs are. In this article we are going to analyze what is currently going on with iron, copper and zinc. Before we analyze each individual metal, there is one very important trend in the mining sector which will affect all three metals, low prices which minimize exploration investments and new discoveries.

figure 1 discoveries
Figure 1: Expenditures and mineral discoveries. Source: Rio Tinto.

 

The low number of new discoveries means that sometime in the future there will be a new supply gap like the one we experienced in 2011. It is too early to call for such a situation now, but those are the future benefits of a well-diversified portfolio with commodities.

Iron

Let us start with the most mined metal in the world, iron. Iron prices have been declining since 2011 after hitting a 30-year high of nearly $200 per ton. Prices then bottomed out in December 2015 at $40 per ton, only to jump to $60 per ton in April 2016 and then slowly decline to the current price of $50 per ton. From an historical perspective, prices are still high, but it is important to analyze the current supply and demand situation in order to see if iron is a good diversification metal, especially as central banks target inflation.

figure 1 iron ore prices
Figure 2: Historical iron ore prices. Source: index mundi.

 

All the biggest iron ore producers recently came out with their Q2 2016 production reports, giving a clear indication of the trend in commodities. The results are mixed, Rio Tinto (NYSE: RIO) increased iron ore production by 10% year over year while BHP Billiton (NYSE: BHP) decreased production by 2% and Brazilian Vale (NYSE: VALE) decreased production by 1%. As all major producers are developing new mining projects—like Vale’s 90 million tons per year S11D—and are able to increase production if necessary, we cannot expect the formation of a supply gap in iron and a surge in prices similar to what we witnessed in 2011. Further, as major producers keep increasing production it will keep a lid on future prices.

In order to be diversified with iron, the best thing is to look at the lowest cost producers who are profitable at much lower prices.

figure 2 iron ore cost curve
Figure 3: Iron ore cost curve. Source: Metalytics.

 

The lowest cost producers manage to have positive cash flows even with iron ore prices below $40, which is still a possibility if we see more global turmoil or slowing in China. On the other hand, iron should be a relatively good hedge against inflation.

Copper

Copper has reached its seven year low in January 2016 with prices below $2 per pound, but the recovery has been much smaller than with iron. Current prices are at $2.20 and copper has been trading in the $2.05 to $2.25 range since March.

figure 4 copper prices
Figure 4: 10 year copper prices. Source: Nasdaq.

 

But copper is expected to enter a supply gap in the next few years as global copper grades are getting lower, big mines are being closed and demand is constantly growing.

figure 5 copper deficit
Figure 5: Expected copper supply gap. Source: Visual Capitalist.

 

A sign of how important copper is comes from the fact that both Rio Tinto and BHP Billiton base their strategic exploration on copper. In 2015, Rio Tinto spent 66% of its exploration budged on copper with 25 of 37 exploration targets being copper focused.

figure 6 rio tinto exploration
Figure 6: Rio Tinto’s exploration. Source: Rio Tinto.

 

A commodity that is already in a supply gap and is a great example of what can happen to copper, is zinc.

Zinc

Similarly to the above described commodities, zinc has reached its multi-year low in January 2016 with prices below $0.7 per pound. But, unlike copper, prices have quickly rebounded to the current $1.03 and the trend looks very positive.

figure 7 zinc prices
Figure 7: One year zinc prices. Source: Infomine.

 

The reasons for such strong performance are an increase in Chinese infrastructure spending, mine closures and a global increase in demand. With current zinc usage a few percentage points higher than production, we should expect even higher prices.

figure 8 zinc supply
Figure 8: Zinc supply and usage. Source: International Lead and Zinc Study Group.

 

Investing Opportunities

The lowest risk commodity investments are big miners with low debt levels and low costs.

Another option is to invest through ETFs that hold metal futures. Such an ETF equally spread in aluminum, copper and zinc is the DB Base Metals Powershares. Higher returns can be achieved by investing directly into specialized miners with low debt and low costs, giving a greater assurance of a profitable investment, however the risks also increase. 

Conclusion

Knowing how metal markets work, that near term supply gaps exist for several metals, and that prices are still close to multi-year lows minimizes risk and makes metals an attractive investment opportunity. But the main point of this article is that commodity metals are a protection against inflation since the metal supply is not flexible in the short term and fewer and fewer profitable mining operations are being discovered. With global central banks keeping interest rates very low, and increasing money supply, sooner or later inflation will kick in. Until that happens and metal prices rise, you can enjoy the high dividends miners are currently paying and have a well-diversified portfolio.

 

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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.

Introduction

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.

538 figure 1

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

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: Mining.com.

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: Mining.com.

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: Mining.com.

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.

538 7 dollar copper

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.

Conclusion

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.