Dr. Copper:
Whilst not quite as spectacular as zinc, copper has shown signs of a real resurgence in 2017. The move started late in 2016 after the copper price ground out a text book basing pattern throughout the first three quarters of the year before breaking out proper in November.
2017 saw those gains consolidated as price traded in a sideways range before leading the base metals complex in breaking out topside a few weeks ago back in late July. Price is currently testing the key $3/lb level, as shown in the chart below.
Figure 3: Weekly copper price candlestick chart, as of Friday, 18th of August, 2017. Source: Thomson Eikon
As with most commodities we follow, we believe the most reliable drivers of the copper price into the foreseeable future are going to come primarily from the supply side of the equation. This is because we know that the industry is mining well above its reserve grade, meaning that over time the industry average mined grade is almost certain to decline.
Lower mined grades mean miners will have to increase the volume of ore they process every year, just to "tread water". It also means we're likely to see a climbing industry wide average cost of production (less copper produced per ton of ore mined/processed), increasingly rendering mines at the higher end of the cost curve uneconomic unless the copper price rises enough to compensate for the declining grades.
A text book example of this phenomenon can be seen at the Escondida mine in Chile, currently the largest copper mine in the world, producing over 5% of global annual supply.
The Escondida mine is currently mining ore that grades around 1% Cu, which is 1.4 x the life-of-mine reserve grade of its sulfide ore body, which currently sits just under 0.6% Cu. In other words, the mine is being "high graded", meaning simple mathematics dictates that mine grades are set to steadily decline into the future.
This phenomenon is clearly visible in BHP's (57.5% owner) 2016 operational update which highlighted a huge 28% year-on-year decline in mined grade during the year. Whilst part of the decline was due to grade variability within the ore body, it highlights a trend of a declining grade profile that's only going to worsen over time.
Figure 4: Excerpt from BHP's June 2016 year end operational review. Source: BHP's June 2016 news release, page 6.
This problem is by no means limited to Escondida, but rather is pervasive across the entire copper sector. With the world’s copper mines not only rapidly depleting in absolute terms (depletion), but also falling in quality by way of grade decline (result of high grading), we believe we're likely to see significant downward pressure on the amount of the copper the industry is able to produce.
Completely ignoring the demand side of the equation (which is harder to quantify, but we are generally bullish on - think the increasing push towards electrification), an industry wide flat to declining production profile is usually a key ingredient in the recipe for higher prices.
To compound matters, low copper prices have all but killed the copper exploration sector, both at a brown fields (near existing mines) and green fields (new discoveries) level. The result, with a couple of notable exceptions, is that there is almost nothing in the way of new world-class copper projects ready to replace depletion from existing stock of copper mines.
This is why we are paying particular attention to exciting exploration projects, new copper discoveries and the few existing high-quality development plays which we believe are becoming increasingly attractive acquisition targets as the copper market turns and producer are forced to look at options to replace their rapidly depleting reserves.
Sam Broom |
