London Calling on a copper conundrum which probably isn't
Published by MAC on 2009-05-11We may be forgiven for failing to understand the forces which, over the past half year of the collapse of debt "securitisation", have stimulated an increase in the bought price of some certain mineral commodities. Gold's fortunes depend on the misfortunes of other commodities in general, and on fluctuations in the dollar exchange rate.
But what about copper?
Whether or not the red metal has indeed come to stand in for "money" (as some gurus will have it) the metal's rise and fall has customarily mirrored that of capital markets and consumer behaviour in general.
The interview with a so-called "corporate development strategist", published below, offers a little insight into why there's apparently been a "bull market" for copper since February 2009. But the "strategist", Gianni Kovacevic is also contradictory. He claims that "we" (in other words "they") are "playing by a different set of rules." But it's quite clear he sees the old assumptions - those of a ubiquitous, self-regulating, "market" - prevailing indefinitely.
Nor does Mr Kovacevic offer anything further as an explanation for this phenomenon than China's recent purchases of refined copper, motivated by the regime's obvious tactic of scooping up supplies when the price of the raw material had apparently bottomed out.
Having said this, Kovacevic acknowledges that actual global demand has "certainly decreased". He claims that: "Certain things took place within the past 30 years to ensure an idiotic oversupply of metals in general, but copper specifically..." So - as always happens, if you follow basic demand-and-supply theory - the price eventually had to plummet.
Speculation
If it picks up during the foreseeable future, there's little telling whether this is because of an actual boost in requirements (as opposed to stockpiling for future possible use). Or if it's the result of "pure" speculation. This happens when stocks of copper are shifted in and out of physical or virtual warehouses, to give the appearance of an increase or decrease in demand - the trademark strategy of hedge funds.
Have copper prices reached such a low ebb that, even if real demand grows, it won't reach the level where many miners can afford to open up new mines? Last month, The International Copper Study Group declared the world copper market to be in surplus, to the tune of 155,000 tonnes in January this year, compared with a deficit of 22,000 tonnes in January 2008. But, according to Kovacevic: "The reality of peak copper is, if the marginal deposits are not able to go into production, there comes a time where peak copper will exist."
That sounds like another contradiction. Kovacevic explains it as meaning that: "If copper goes from $2 to $5 a pound and stays there for a while, that allows marginal and yet more marginal deposits to go into production economically. That could bring about a peak copper situation for future generations."
Little or no evidence
But Kovacevic doesn't offer firm evidence of this being the case, settling for the extraordinarily shaky claim that: "As we go forward in a greener and cleaner world, we need to remember that to create green energy requires more copper. Electricity needs copper. When we get away from fossil fuels, whether it's cars or the way we generate electricity, we will require more from copper and its alloys."
Interestingly, Kovacevic isn't putting any of his own company's investment into those marginal deposits; nor indeed on future copper output from potential high-grade mines in DR Congo, Eastern Europe, Mongolia, Ecuador, Peru (none of which he mentions), or on north American prospects like Anglo American's much-criticised Bristol Bay in Alaska.
Instead he's promoting what he terms the "greatest locations for copper" - in Arizona, Nevada and Chile, where a substantial proportion of capital costs for new projects have already been found.
Last year, MAC published a summary of the analysis by the UK-based Simon Hunt consultancy, which argued that copper's spectacular rise until 2008 was largely due to speculation by market traders.
Hunt asserted that there was no true rising real demand for the refined metal; and that any such demand would rise by 2% at most over the next few years at most. Indeed, he said, it may actually fall, putting in jeopardy both planned expansions and future mined output. See: http://www.minesandcommunities.org/article.php?a=8951
Of course that scenario will be compromised if speculators are allowed to continue manipulating the metal's price. It also presupposes that the whimsies of people like Kovacevic will be regarded with the heavy weight of scepticism they deserve.
Sources: International Copper Study Group report; Wall Street Journal, 29 April 2009
Why Copper price surged by 50% in three months
Commodity online
29th April 2009
What's driving copper to its recent high of $2.20 a pound? If demand is down, how is it possible that the price of copper went up 40% to 50% within the last three months alone? "We're playing by a different set of rules now," says Gianni Kovacevic, corporate development strategist at Global Opportunities AG. In this exclusive interview with The Gold Report, Gianni discusses the changing face of copper and the new rule book being written for it.
The Gold Report: Gianni, can you give us your short-term and long-term view on the copper market? Any sense of what's driving copper to its recent high of $2.20 a pound?
Gianni Kovacevic: All investors need to recognize that commodities, and copper in particular, are following a new rule book that is still being written. In the past week or so, many people have been saying in the media that "copper is money." Certainly any commodity that is based in U.S. dollars can be considered money, and within the past six months, since the breathtaking fall of all commodity prices in all asset classes, we've seen copper bottom out at about $1.25.
Since then, during the last three months, it has risen back up 40% to 50%. As copper traded below $1.50 for an extended period of time, the world's biggest user of copper, China, was able to buy market-finish copper on the market at $1.25 to $1.50.
There are sophisticated people that still say that it's going to fall back into the $1.00 a pound range-which is the marginal cost of production, or what it costs copper miners to get it out of the ground. In this particular market, we're in a situation where companies cannot get debt or equity financing-at least they were not able to at the end of '08 and the early part of 2009. So why go through the exercise of developing a project when you can buy a finished product at the price of the cost of production?
A lot of the world's experts were scratching their heads because all they saw was demand destruction and terrible balance sheets. Nobody was buying anything; nobody was shipping anything. How in the world could copper go up in a market like that? Demand and supply tells us that when people aren't buying stuff, the price should go down, yet as I said, the price of copper has gone back up significantly in the last three months.
My answer to all this is that we're playing by different rules now. Anyone that's looking at their old rule book is going to get it wrong. The market is always going to decide what the price of anything-and particularly commodities-is going to be, and the market is telling us that there's someone or something out there that sees value in copper between $1.50 and $2.00 or $2.20 a pound.
TGR: Gianni, since all the commodities crashed together, is this really just a leveling out to what the price should be, as opposed to some type of hidden demand that we don't see that's going to send copper higher?
GK: Time will determine what the new mean price that copper is going to be. For 30 years, copper always reverted back to about a $1.00 a pound. In 1980, copper traded for $1.00 a pound while, for the first time in the United States, gasoline climbed to over $1.00 a gallon. The Big Mac was less than $1 and a candy bar was 25 cents. And for 30 years, the price of copper always went back to $1.00.
Certain things took place within the past 30 years to ensure an idiotic oversupply of metals in general, but copper specifically, so that people have it in their minds that it should always fall back to that level. Well, the buying power of $1.00 is a lot less today. So the market is going to tell us what the real long-term price over the decade should be for copper and maybe it's $2.00, maybe $3.00.
Given that a Big Mac is over $3.00 today and gas is $2.50 to $3.00 a gallon, and it costs $1.25 or $1.50 to take copper out of the ground, that suggests to me that the price should be $2.00 or $2.50, or at least more than the 30-year mean price of $1.00.
Demand has certainly decreased. Let's use automobiles as an example to put demand destruction into perspective. A lot of people have the notion that automobiles are massive users of copper and they are. But in 2008 approximately 65 million cars were sold. This year Hyundai Corporation believes that car sales will decline 7% or 8%. That would suggest that there will be 60 million cars sold in 2009, albeit in China car sales are, in fact, increasing.
So with the average car now using 30 kilograms of copper, that's 1.8 million tons of copper in 60 million cars. In 2008, the world used around 18 million tons of refined copper. So mathematically, 10% of the annual yield was used or will be used in automobiles in 2009. The difference between 2008 and 2009 in the demand-destruction scenario is 150,000 tons less copper. Is that demand destruction? For some people it might be. What about when the 6.6 billion people in the world or the 1.3 billion Chinese buy again?
Let's look at the supply side. Chile's guidance for annual supply has been disappointing. For 2008, they said they would produce 5.75 million tons of copper. At the end of the year, they produced 5.35 million tons-400,000 tons less than guidance. Of course, there's a little bit less demand.
So for every pound of copper that's not going to be needed because of decreased demand, there's likely a pound of refined supply or previously reliable scrap that's not there or not going to be there. You have a relatively tight balance. There's not a lot of copper in storage- there are now falling stockpiles of 450,000 to 460,000 tons, or eight or nine days' worth of copper.
TGR: Are we facing a peak copper situation where the total available copper-either from scrap or potential production-is decreasing? Are some of the copper producers going to go bankrupt?
GK: Now that copper has rebounded to $2.00 a pound, pretty much most of the people within the business probably can keep the lights on; and the middle-cost producers with the good gold by product are making money right now. Peak copper is something that certainly exists in the long term. Copper, like all commodities, is finite.
The demand for copper has grown 4% year-over-year for over 100 years. World wars and other crises did not matter over the long term. The longest trend ever is the ascent of man and 6.6 billion people procreating, and I think that means demand will continue after this crisis is over.
Copper demand grew from 500,000 tons in 1900 to the 18 million tons we use now. It's going to continue to grow. It's very difficult to turn demand off like a light switch the way you can turn off supply. Earthquakes, electricity problems, strikes, pit collapses-when crises like those happen to a very large operation, supply goes off stream on the spot. The reality of peak copper is, if the marginal deposits are not able to go into production, there comes a time where peak copper will exist.
If copper goes from $2 to $5 a pound and stays there for a while, that allows marginal and yet more marginal deposits to go into production economically. That could bring about a peak copper situation for future generations.
TGR: Are you expecting copper to go above where it is today; and, if so, by how much?
GK: Again, I believe we're playing by a different rule book, and I don't like trying to predict the future. We've had a continuously coiled spring for 30 years, and copper always reverted back to $1 a pound. That boat has sailed. The market will establish the new mean price for copper because it'll find that balancing point.
And within the new rule book, one chapter has already been written, and that has to do with technology. As we go forward in a greener and cleaner world, we need to remember that to create green energy requires more copper. Electricity needs copper. When we get away from fossil fuels, whether it's cars or the way we generate electricity, we will require more from copper and its alloys.
TGR: Gianni, given your interest and enthusiasm in copper, how does one play this particular angle in the market?
GK: Well, certainly trading in the physical commodity is a very sophisticated game. I don't participate in that. I'm a value investor and I look at things over the long term, looking for an underlying commodity, be it oil or be it copper. You have to look at companies that have the strongest balance sheets and management teams. Any company that's handcuffed by debt is probably going to have a harder way out. You also want to look at political stability; everyone has his or her own threshold of what that means, so I leave that up to the individual investor.
With copper, we look for the greatest locations in the world for copper-Arizona, Nevada, Chile. For example, we are shareholders of Quadra Mining Ltd., and they're situated in those jurisdictions. They have 100% ownership of their projects and have an extraordinarily high by product of gold. In 2008, they produced 137,000 ounces of gold.
They are not shackled by a bunch of debt. They've been able to grow organically with very intelligent acquisitions. Just recently, they acquired Centenario Copper Corporation, which, oddly enough, had 100% acceptance from the shareholders of Centenario-a huge vote of confidence for Quadra's management team.
They're now going to have a third operating project and are going to produce 230 million pounds of copper in 2009. That's going to grow to 280 million pounds of copper in 2010, or about 130,000 tons with a significant gold by product. Their guidance is 100,000 ounces, but already in the first quarter they reported a few days ago, they produced 35,000-36,000 ounces for the quarter, so they're tracking again to be well over 100,000.
This is a company that does not trade at a fantastic multiple. The stock was C$27 and it fell to about C$2. It currently trades at about C$6, so I think this is one way that people can play copper long term because you have a company that's demonstrated very responsible growth even in these troubled financial times.
TGR: Gianni, aren't there a lot of analysts that are currently recommending Quadra? Aren't they one of the darlings of both Wall Street and Bay Street?
GK: We filter a lot of research, high and low targets to get the good, the bad and the ugly on the stories that interest us. There are actually 15 analysts that we know of that cover Quadra. Tom Meyer of Raymond James just revised his to C$19 a share. You can look at the downside and understand the logic of the analysts that are still in the low range with respect to copper and understand the rationale behind the low target. It's pretty unusual to see that kind of upside target of a TSX S&P company like Quadra Mining, so we like that. We think it's very rare to see a company of this size that has that much following.
TGR: You are also interested in molybdenum, correct?
GK: We're following molybdenum very closely. Molybdenum has behaved in a very funny way lately because the Chinese, all of a sudden, have come into the molybdenum market. Molybdenum is currently at $8 a pound, and China, which has traditionally been very self-sufficient with its domestic production of molybdenum, has imported about 10,000 tons since December.
That's more than they imported, basically, in all of 2008. We look that as a signal that this is probably physical usage and that they cannot produce it for that price. Because molybdenum does not really affect its end use in a pipeline, for example, if molybdenum is $8 a pound or $30 a pound, the cost of 1km of pipeline is not going to change significantly.
Here's something else that I think is important. We believe copper sets the barometer of the global economy; you could also say that molybdenum is certainly on the pulse, too. With its very high melting point and its anti-corrosive properties, it's used extensively within infrastructure and energy transport and creation. So you're going to see it used in things like pipelines, construction, and any kind of energy projects.
When we see a turn in moly, I think you're going to see a dramatic turn. It's continued to fall, down to the high $7 range and finally has upticked again to over $8. Now that moly has turned, that could signal the bottom and we can expect and will monitor a potential climb to the upside. Again the interesting thing is that the Chinese are buyers.
So another company that we like that's sort of a proxy on moly and still within the copper space is Mercator Minerals Ltd.. It's a brand-new operation in Arizona with a moly production focus, with 5 million pounds this year and expanding to just over 10 million pounds next year with Phase 2 completion at their Mineral Park operation. As well, there is 50 to 60 million pounds copper production for diversification. Their cap-ex replacement for operations is around $500 million.
TGR: Any other companies that come to mind that you think our readers should be taking a look at?
GK: A company that has a lot of advantages and is on the path to production (and this is a very difficult market for that), is Copper Mountain Mining Corporation, located in Southern British Columbia. What separates them from other companies is the fact that it was a past producer; they've got about $160 million worth of infrastructure and development in place. That's about $5 per share of dilution that will not need to take place. They've signed a Memorandum of Understanding (MOU) with Mitsubishi, who is the strategic partner.
According to that MOU, Mitsubishi is going to earn 25% of Copper Mountain Mining for $28.75 million, or about $4.50 per share, and they're going to help finance by way of debt about $250 million of the overall development costs. The development costs per the last study were about C$430 million. This pretty much completes their financial obligations. I believe all that Copper Mountain would need to finance on their own is somewhere in the area of about $50 million. So it's a big project and it'll be a pretty big producer, 50,000 tons a year and, more importantly, they've got the big partner with Mitsubishi.
A lot of companies just can't get capital. Copper Mountain, according to this MOU, only needs about $50 million to go into full production and they do expect that to start in 2011. So it's a company that's got a very low market cap, about $20 million, and the blueprint and groundwork to finance a project in this economic climate with a very strong partner.
TGR: Thanks, Gianni, for this introduction to the world of copper. We appreciate your time.
By arrangement with: http://www.theaureport.com
[London Calling is published by Nostromo Research. Opinions expressed in this column do not necessarily represent those of any other party, including the editors of the MAC website. Reproduction is welcomed so long as full acknowledgment is given to Nostromo Research and to any sources quoted.]