…is giving bulls some hope

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Globe & Mail Business Section
http://www.theglobeandmail.com/globe-investor/investment-ideas/glimmer-of-hope-for-copper-bulls-in-2016-amid-tightening-supply-chain/article27824402/

Andy Home - London — Reuters
Published Thursday, Dec. 17, 2015

It’s been a tough year for copper bulls.

One of the industrial metals most associated with the boom years in China has been hit hard by the country’s lurch away from its previous fixed-asset investment growth model.

Talk of the “new normal” and of a Chinese “slowdown” doesn’t capture the severity of the demand shock experienced by all the metals, copper included.

On the London Metal Exchange, the price of three-month copper peaked at $6,481 (U.S.) a tonne in early May, since when it’s ground steadily lower to a current $4,550.

The best that can be said is that copper hasn’t fared as badly as other metals such as nickel, which is back at the bombed-out levels seen at the worst of the global financial crisis.

Copper is some way off its 2008 trough below $3,000, although that may only encourage more bear attacks, particularly in China, where shorting metals has become the hot trade for expressing a negative view on the country’s economic prospects.

The demand “slowdown” in China has been exacerbated by a supply surge. Again this is not unique to copper. Producers of just about every metallic commodity were still chasing China’s “old normal” of rapid infrastructure-fueled growth even as that model was unraveling.

But if there is a glimmer of hope for copper bulls next year, it lies in copper’s infinitely unpredictable supply dynamics. Because this week has brought tangible evidence that the supply chain is starting to tighten, very much against consensus expectations.

A fractured benchmark

The evidence comes in the form of the first major 2016 copper concentrates supply deal signed between Chilean miner Antofagasta and Chinese smelter Jiangxi Copper.

Treatment and refining charges have been set at $97.35 and 9.735 cents a pound, which is what Jiangxi will charge for transforming Antofagasta’s concentrates into refined metal.

The level of charges has come as something of a surprise. This year’s were set at $107 and 10.7 cents, and Chinese smelters were looking for something similar for next year, not unreasonable given that big new mines are still increasing with commodity textbook bad timing.

Of course, it remains to be seen whether this deal serves as a benchmark for other miners and smelters.

Antofagasta has not in the past been associated with setting the annual benchmark. That role has been played by Freeport-McMoRan, which is presumably still negotiating with smelters.

Moreover, the whole concept of an annual benchmark in the copper concentrates market has become increasingly questionable.

BHP Billiton, which used to be the benchmark leader, has shifted ever more tonnage away from annual sales into shorter-dated or even spot trades.

Compounding the fracturing of the old annual benchmark system has been the proliferation of new mines producing “dirty” concentrates with high levels of unwanted byproducts such as arsenic. These are priced at a discount to “clean” concentrates and often have to be blended before being sold to smelters, adding a layer of intermediate complexity to the old pricing model.

But if you want a feel for what’s happening in the copper raw-materials market, deals such as that inked between Antofagasta and Jiangxi are as good an indicator as you’re going to get.

And this one suggests there are going to be fewer concentrates around next year than widely anticipated. That’s why Jiangxi is going to receive less treatment revenue than it and other Chinese smelters were probably hoping for.

And, it’s worth stressing, charges have fallen despite the fact Chinese smelters plan to cut production by 200,000 tonnes next year with a flow-through impact on their raw materials needs.

Copper supply: predictably unpredictable

So what’s happened to the expected supply surge?

As ever with copper, supply has turned out to be predictably unpredictable.

World mine production increased by 3 per cent in the first eight months of this year, according to the International Copper Study Group (ICSG). Which by copper’s standards is a fair pace of growth, just not as much as everyone was expecting.

In October last year, the ICSG forecast mine growth of 6.7 per cent this year. At its meeting in April, 2015, that figure was slashed to 4.4 per cent and it was cut again to 1.2 per cent in the ICSG’s most recent forecast.

Such downward revisions partly reflect accumulating production cutbacks as miners react to lower prices, cuts which largely haven’t shown up in the ICSG’s figures for the first eight months of the year.

Freeport, for example, has just announced the complete mothballing of its Sierrita mine in Arizona, taking another 45,000 tonnes of annualized capacity out of the market.

However, the really big cuts taken by both Freeport and Glencore are to their SX-EW mines, which produce refined metal, not concentrates. As such they shouldn’t in theory affect smelter treatment charges.

As important as price-related cutbacks to the concentrates market have been, the multiple unforeseen production hits arise from everything from low grades, technical outages and, in the case of Chile earlier this year, heavy rains.

New mines, meanwhile, have been plagued by the usual start-up delays. To take just one of many examples, the Caserones mine in Chile, with full potential capacity of around 150,000 tonnes per year, is going to struggle to meet even its already downgraded target of 64,000 tonnes this year.

More of the same next year?

And the combination of price-related cuts and chronic mine underperformance looks set to continue to constrain supply next year.

Citi analyst David Wilson notes that heavyweight research house Wood Mackenzie has been steadily revising downward its mine growth projections for next year from 6.4 per cent at the end of March to a current 1.4 per cent.

That’s equivalent to around 1.2 million tonnes less copper.

Then there is China’s own mined production.

No one likes the official figures from the National Bureau of Statistics (NBS), which are notoriously inconsistent. To the point that the NBS is not actually going to release any data for November due to “technical reasons.”

But the trend in copper mine production in China was steadily downward over the first 10 months of this year.

Which makes sense because parts of China’s copper mining sector are thought to be relatively high-cost and, excepting those integrated into state producers, highly price-sensitive.

Falling domestic supply and less overseas supply than expected appear to have forced Jiangxi to bite the bullet on accepting lower treatment fees for next year.

None of which is to say that the price of London copper, which is the price of refined metal, will miraculously recover any time soon.

There is still the not-so-little problem of weak demand, particularly that in China.

But copper’s market balance is ultimately determined by what comes out of the ground, and this early 2016 deal between Antofagasta and Jiangxi suggests there is going to be less copper coming out of the ground next year than everyone thought.

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Readers’ comments:

Thank you for this intelligent and considered piece - it's much preferred to the shrill headline chasing we sadly are presented with so often. I realize it's harder work but know it's appreciated.

reply to above

Glad you liked the piece. The writer, Andy Home, is the best in the business when it comes to the base metals industry. Darcy Keith/Globe and Mail