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Tight copper supply and robust industrial demand combined with a positive economic outlook from China can present investors with interesting buy opportunities for the red metal in 2012. Columnist Amine Bouchentouf gives his recommendations for copper companies to keep an eye on.
Columnist Amine Bouchentouf is a partner at Parador Capital LLC, an institutional advisory firm focused on commodities and emerging markets. He is the author of the bestselling Commodities For Dummies, published by Wiley. Amine is also the founder of Commodities Investors LLC, an advisory firm dedicated to providing insightful information on all things commodities.
Copper was one of the worst performing metals in the commodities complex in 2011. Copper prices were down a whopping 23 percent for the year, from $4.44/lb to $3.43/lb on the COMEX. Even more important than this violent price drop, was the volatility copper prices experienced throughout the year.
In the first half of 2011, copper prices traded in a narrow range between $4.00/lb and $4.45/lb. Beginning in July however, the red metal was subjected to a heavy sell-off, followed by a brutal August, which had prices drop almost $1.00/lb. Even though the physical market remained in a historically tight situation, traders sold the metal on fears of a Eurozone economic implosion and any spillover effects that may have in the global economy.
As the Eurozone crisis took center stage in global markets, traders went on a heavy selling spree selling any asset that was perceived as a risk asset—and copper got caught up in this massive de-risking cycle.
A moderately bullish outlook for copper in 2012
As we enter 2012, the picture looks a lot more bullish for copper prices. It seems that the selling in 2011 was massively overdone by traders, and it looks as if the European meltdown has been somewhat priced in. As we enter the middle of the first quarter, the market is focusing on the fundamentals of the copper market: namely, a very tight supply situation combined with positive growth coming out of China.
Like most base metals, copper is now inextricably linked to the Chinese growth story. China accounts for about 40 percent of global copper consumption, so economic growth in China is now one of the biggest factors influencing copper prices. Chinese growth is expected to remain robust throughout 2012, even given the European slowdown.
In order to get a precise picture of Chinese influence over copper prices, we have to examine the exact market drivers in China. When you analyze the data carefully, it’s clear that Chinese copper demand is driven by the Chinese construction industry. Specifically, Chinese industrialization is driving copper demand: the need for copper to build electrical power plants, transportation infrastructure and housing infrastructure is a huge market driver.
The Chinese government plans to spend over $400 billion between now and 2015 on infrastructure projects. Meaning that even if private sector demand softens, public spending will more than make up for this slowdown. Indeed, China has plans to build over 10 million housing units to accommodate all the workers moving into cities from rural areas. Considering that over 75 percent of Chinese copper demand is for construction purposes, it’s easy to see why China will continue to be a major purchaser of copper in 2012—and thus helping keep upward pressure on prices.
Supply side disruptions
Another interesting factor about China is that it is one of the top producers of copper worldwide. Indeed, China produced almost one million metric tons of copper in 2010 representing about 7 percent of global supply. A key issue facing the market is that Chinese production is set to decline due to rising energy prices.
More importantly are supply disruption issues in the industry’s biggest producer, Chile. Production in Chile hit a 5 year low in 2011, plagued by issues such as labor strikes, heavy rainfalls and tougher mining conditions. Chilean mining workers are demanding higher wages and better benefits to keep working the mines; production companies and workers have been deadlocked in negotiations which have resulted in crippling strikes throughout the country. This has had an adverse effect on production.
In addition, mining conditions are getting much tougher not only in Chile but around the world. It’s becoming more costly to find higher grade ores as miners have to dig deeper, deploy more capital and spend more time in order to produce copper. Finally, there are other issues in the world’s biggest producer that no one has control over, and that is adverse weather conditions. Heavy rainfalls in Latin America in general and Chile in particular, have resulted in delayed projects.
All in all, the global supply side picture remains very tight. Even the legendary Glasberg mine in Indonesia (one of the world’s top 3 mines) has not been immune from disruptions, as workers went on long-lasting strikes which have crippled production. I expect copper supply to remain extremely tight in 2012, and beyond.
What’s an investor to do?
When you combine a tight supply scenario with a robust industrial and economic outlook in China and other emerging markets, one would expect copper to perform well in the first half of 2012. Copper prices may hit 2011 highs of $4.50 per pound. Already, we’re seeing copper prices increase by single digits for the month of January. This presents an interesting buying opportunity for the discerning investor.
One company worth taking a look at is Xstrata (LSE:XTA), which is heavily involved in copper production. Xstrata has operations in several important mining jurisdictions including in Chile, Peru, Argentina and Australia. The company owns both upstream production assets and also processing facilities, thus giving you exposure across the value chain. With net profit margins of 18 percent this is a good way to play an industrial rebound in base metals and copper.
For a less mature company in the space that can provide growth opportunity, take a look at Red Metal Resources Ltd. (OTCBB:RMES). Red Metal is active in Chile’s prolific Candelaria mining district, where large amounts of the world’s copper deposits are located. Red Metal has two interesting exploration projects in advanced drilling stages that may yield reserves in the future.
All in all, my outlook for copper for 2012 is bullish which presents some interesting opportunities for the discerning investor.
Securities Disclosure: I, Amine Bouchentouf, hold no direct interest in the companies mentioned in this article.