More stimulus could be supportive of the copper price going forward. This is important as China consumes 40% of global copper production and has based much of its economic growth on the real estate sector – crucial for copper.
Third urbanization and technological advancement (two themes we remain bullish on over the long term) are powerful forces to halt. If vehicle electrification ever takes hold to become 10% of the global automotive fleet this would require an additional 1 million tonnes of copper on global markets every year. Though data is tough to pin down a full electric vehicle requires around 165 pounds of copper. Add in hybrids plug in electric vehicles busses etc and you can see how automotive growth underpins the secular bull case for copper. This of course ignores growth in traditional automotive demand as well as infrastructure. This additional million tonnes is the approximate equivalent of one new Escondida. While this penetration is not imminent (perhaps a decade under the most bullish scenario) it does give you an idea of how “new” uses for copper need to be factored into future demand forecasts. The lithium ion battery business is approximately $18 billion in size today and forecast to grow to $75 billion by 2020. This is impressive for a number of reasons not the least of which is the fact that the entire rechargeable battery business globally is only $50 billion in size today according to . Clearly more than just lithium cobalt etc will be needed to achieve these projections. Copper is at the center of this growth.
Fourth head grades appear to be falling and mining costs in general are increasing. (BHP: NYSE) stated earlier this year that grades at their Escondida mine will fall by 24% in FY2016 which will impact results in the near term until productivity measures already underway will increase throughput and production. (AAL:LON) has raised similar concerns with grade declines and variability at their Los Bronces mine in Chile. Clearly investing in productivity is only going to increase in importance. While much of the global copper cost curve is profitable at current prices (approximately 90% according to industry data with 50% still profitable at approximately $1.60) any sustained supply disruptions will require a higher copper price to incentivize capital expenditures and hence new supply.
The Fatal Conceit
Predicting commodity prices has widely been viewed as a “fatal conceit” to steal a phrase from Friedrich Hayek and that’s not what this note is aiming to do. Any rational observer could agree though that the rout in the copper price appears somewhat overdone. While the major copper producers focus on organic growth and balance sheet strength by leveraging productivity the steady demand for copper remains in place. Going forward a close study of copper grades copper inventories and GDP growth are crucial as these metrics have historically been the drivers of the price of copper. Additionally copper is no different from any other commodity in that the lowest cost producer always wins. For this reason we remain focused on two types of companies in the copper space: low cost producers who can generate substantial free cash flow and companies with an acquisition strategy of consolidating high quality assets at a low relative cost such as Copperbank Resources (CBK:CSE).