Will The Copper Rally Last?

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Is the rally in copper driven by fundamentals or speculative? This is a question brokers are asking and, as usual, the answer is not straight forward.

-Goldman Sachs: copper price justified by synchronous global growth, lower US dollar and disappointing mine supply
-Credit Suisse: China's construction boom to fade in 2018 and, consequently, demand for copper
-Impact of electric vehicles on copper demand unsubstantiated as yet, and long-dated
 

By Eva Brocklehurst

Copper prices have surged towards US$7000/t (US$3.20/lb) for the first time since 2014. Goldman Sachs suggests the rally is fundamental, as speculative positioning is consistent with current economic activity.

The broker believes the current level of copper prices is largely justified by strong and synchronous global growth, a depreciating US dollar and disappointing copper mine supply. Copper still tracks Chinese manufacturing PMI data closely and this suggests the rally is not completely out of line with fundamentals. The market may not be fully appreciating the synchronous nature of global growth and the reduced downside risks in China, the broker contends.

Furthermore, supply that was anticipated has never materialised and, while expecting healthy mine supply growth over the next two years, the broker believes cost inflation is now building. Goldman Sachs expects the copper market to face a deficit of 130,000t in 2018 versus a previous forecast of a surplus of 150,000t. Strong growth in demand and US dollar weakness are expected to translate into a 10% increase in copper prices from 2017 to 2018.

Copper is being used as investment proxy for global GDP. Credit Suisse agrees with that observation but concludes this is speculative demand that is highly volatile and cannot be baked into expectations. Fundamentals do not show tightness in the market, and the broker believes this is what will, ultimately, control prices.

Growth in China's copper consumption has been stronger than expected this year as the housing construction boom sustains demand for copper-bearing appliances as well as building wire. Credit Suisse expects this construction effort will fade in 2018, and consumption growth rates slip to 1.5% from 4.7% this year. Reduced demand will provide a declining trend for price forecasts.

In examining the bull argument centred on a decline in mined copper output and a reduction in grades driving higher prices, Credit Suisse suggests the apparent decline in mined copper four years out is based on investment decisions, and not a new development.

As for grade reductions, these are slight, partly reversible and partly related to technological advances that allow processing of lower grades. Cost efficiencies, the broker believes, and falling strip ratios, are likely to mean costs at mines reduce, not rise.

Credit Suisse upgrades copper price forecasts and accepts that in the long-term, there is potential for stronger demand as the EV revolution matures in developed countries and India, Indonesia and Vietnam urbanise. Allowing for new mines and potentially higher capital expenditure the broker puts the long-term price at US$3/lb. Long-term in the broker's forecasts commences in 2026.

Electric Vehicles

Goldman Sachs estimates that as a base case in which 8% of automobile sales in 2025 are electric vehicles (EV), copper demand for the additional electrical wiring would total 850,000t. Still, caution prevails at the broker on the future of mass adoption of EV, and extra copper demand is not built into projections.

Goldman Sachs is sceptical whether battery technologies will advance fast enough for EV to be competitive, and whether or not input materials such as lithium and cobalt can ramp up quickly enough for the numbers expected to be produced. Nonetheless, if EV production accelerates it could still offers significant upside to copper prices.

Credit Suisse, in examining the argument that EV, declining copper grades and a peak in mine output will require a higher copper price, notes automotive is a small segment of copper demand, at around 7%, and this limits the impact of EV. As well, the growth is from a low base so its long-dated.

Credit Suisse upgrades copper price forecasts. Allowing for new mines and potentially higher capital expenditure the broker puts the long-term price at US$3/lb. Long-term in the broker's forecasts commences in 2026.

Copper Stocks

Copper prices have rallied past UBS forecasts for 2018 of US$3/lb.While preferring OZ Minerals ((OZL)) to Sandfire Resources ((SFR)) in copper, the broker suggests a few of the non-pure copper plays and gold names have significant copper credits which stand to benefit from these higher prices.

Independence Group's ((IGO)) Nova mine is expected to produce, along with a key nickel product, 10-12,000t copper. FY18 is a pro-rata year as the mine is ramping up but in FY19 UBS estimates a US$0.25/lb lift in the copper price would reduce forecasts costs by -11%. At a group level copper is around 15% of revenue in FY18 and the broker suggests Nova will make money through the cycle.

A US$0.25/lb increase in the copper price would also lower costs for Newcrest Mining ((NCM)), Evolution Mining ((EVN)) and OceanaGold ((OGC)) by an average of -2-3%. While the reduction is small, the broker notes the Australian gold sector has been improving and therefore, the relevance of even a minor drop down the cost curve could be enough to excite the marginal investor.
 

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