Structural trends ahead are electrification, renewables, EVs, increased travel and continuous, fast economic growth in developing countries with approximately 6 billion people. For all of that, you need copper.
On top of it, copper is in limited supply, to cater for the growth in demand, prices are bound to increase. This creates a very positive risk/reward investment opportunity.
Further, the current sentiment, based on a myopic view of the situation, is negative and copper miner prices are suppressed alongside other commodities.
The thing with copper (COPX) is that the market is betting on prices going down in case of a global economic slowdown or recession. Given that supply is relatively fixed, any change in demand would be very detrimental for prices. In 2009 copper went below $1.5 per pound.
Furthermore, many miners leverage themselves, invest in marginal projects and consequently, any kind of economic slowdown impacting demand, makes things very ugly for the whole sector. So, oversupply leads to low prices, but given the volatility of the sector, supply gaps lead to extreme price spikes.
As investors, we have to look at the long-term balance, buy miners when copper prices are below long-term sustainable levels and patiently wait for prices to return above long-term balance levels. The key is to own miners that will survive no matter what and buy them when their prices are historically low. The Copper Miners ETF (COPX) is still 70% below 2011 levels.
In this article, I’ll explain my long-term copper investment thesis by discussing:
If you prefer watching to reading, enjoy my video.
The Strategic Investment Advisor Group recently held a Natural Resources day with industrial experts at the Hotel Savoy Baur en Ville in Zurich. I will use many of their presentation charts to put copper into a long-term, but also short-term perspective.
Demand for copper is more stable than perceived by those who just look at copper prices. It is in line with global growth. I think we can expect demand for copper to continue to grow at rates similar to global economic growth.
The price volatility of copper is no indicator for demand. Copper prices are extremely volatile, but even during the Great Recession, demand for copper wasn’t declining.
Copper demand will stay strong, EVs or no EVs. Albeit I consider EVs and electrification a nice added bonus. For example, in the recently discussed 2020 Dutch budget, the plan is to add 1.8 million charging stations. That will require lots of copper, and if countries like Norway and the Netherlands are at the forefront of what is going to happen, the future is extremely positive for copper. The new Chinese 5-year plan and significant grid investments also support demand.
Mine production is slowly increasing, but the current investment level is not enough to sustain production growth, that is expected to actually decline post 2024.
The thing is that copper is not easy to find anymore, it is getting deeper and more expensive to mine. We see the operational issues Turquoise Hill (TRQ) is having with its Oyu Tolgoi mine in Mongolia. Consequently, I don’t think deep mining projects like Rio’s (RIO) Resolution mine or Hudbay’s (HBM) Rosemont project are feasible at current copper prices (no permit is a benefit for the company).
Investments in exploration have also been low over the past years and all of the large mines have actually been found by our great-grandfathers.
So, there will be less copper out there and growing demand. The World’s copper resource base has been growing at the slowest rate over the past 100 years.
Low copper prices don’t create enough incentive to invest in replacing or increasing production. Investments since 2016 have been barely enough to replace D&A costs.
The over-investment and under-investment cycles lead to the common boom and bust cycles in the industry. The only thing we have to do is to buy in a downturn and sell in a boom. A similar situation is happening within all metal sectors.
Furthermore, if India continues to grow at current rates, it might replace China as the largest consumer of copper in the next couple of decades.
So, developed markets will continue grow on stimulus while emerging markets on their natural forces, deserved growth and improvement out of poverty.
As for copper prices, those will average above cash mining costs plus a premium. Who would invest in a new mine at a 5% internal rate of return? 20% is the minimum. This implies copper prices at above $7,000 per ton for most new projects. The current price is $5,700. This is at unsustainable lows. I assume average copper prices over the next decade to be above $7,000 with spikes above $10,000. That is $3.18 per pound with spikes to $4.5 as a minimum.
So, copper prices will spike, but we have to time things very well, as it is possible for them to crash too.
Given the discrepancy between the cyclically adjusted price to earnings ratio (CAPE ratio – that takes 10 years of earnings into consideration) and the S&P 500, it is time to be overweight mining stocks in one’s portfolio. But, keep in mind and be prepared for volatility. Own those miners that can’t go bust.
Now, if we have a recession, many projects will be postponed or scrapped, which means the boom afterwards might be even bigger. In any case, over the next 5 years, copper will be in a supply gap.
Given the low valuations, low investment environment, the market’s negative sentiment for copper miners, I believe copper offers one of the best risk versus reward investment opportunity in the current environment, even if we have a recession in the coming years. A recession would subdue prices temporarily but amplify the boom afterwards. Over the next 10 years, I wouldn’t exclude gains between 300% and 1,000% on copper miners, depending on the leverage and mining costs.
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