The Potential Earnings Power of Copper Miners

Topics: Copper, Commodities, Energy, Stocks

First appeared in Q2 2021 letter

Copper made a new all-time high during the quarter. After bottoming in January 2016 at $1.94 per pound, copper rallied 150% to reach $4.77 on May 11th 2021. Although copper pulled back somewhat, it remains at $4.32 — the highest level in a decade. Far from being over, we believe this copper bull market has just started. As we have written in the past, we believe that the current cycle will ultimately take copper prices above $10 per pound. Although this may sound outlandish, copper rallied seven-fold from its 1999 bottom of $0.61 to its 2011 high of $4.57 per pound. Our models tell us the fundamentals are much better today than they were during the last bull market. Copper stocks have been strong performers as well. The average copper mining stock, as measured by the COPX ETF, is up nearly 100% year-on-year and 20% year-to-date.



Generalist investors are beginning to take notice and are establishing positions in copper mining equities, helping push prices higher. We have noted in the past how investor interest across the natural resource equity space has remained muted despite prolonged periods of very strong performance over the last two years. This has been particularly true with gold and energy-related equities. Flow of funds into the various energy and precious metal equities ETFs have been de minimis, which tends to be a good proxy for investor interest. The same has not been true for copper stocks. Shares outstanding of the COPX are up 319% so far this year and 640% compared with the same time last year, as investors have rushed into the space. By comparison, even though E&P stocks are up 66% year-to-date and nearly 100% year-on-year, shares outstanding of the XOP ETF are flat.


Thus far, most investors have been attracted to the copper equities due to copper’s robust demand outlook, given that renewable energy and electric vehicles are both extremely copper intensive. Furthermore, several countries still must add large volumes of copper to their installed base to meet demand for things like electricity distribution.


Despite COVID-related disruptions, 2020 was an extremely strong year for copper demand. According to the most recent data from the World Bureau of Metal Statistics, global refined copper demand grew by 900,000 tonnes — the fastest rate since 2014. While many countries, notably India, experienced weak demand as construction and power projects were delayed due to shutdowns, Chinese demand surged by 1.7 mm tonnes. While some copper bears believe China is overconsuming, we believe otherwise. Many analysts compare annual copper consumption with real GDP and conclude that since China consumes over 50% of the world’s refined copper but does not generate 50% of the world’s GDP it must be overconsuming and potentially even stockpiling.


We prefer to look instead at the cumulative installed copper in an economy compared with its wealth and based upon this metric, we believe Chinese demand will continue to accelerate for the next several years. Ultimately, it is possible that China will need to consume nearly 75% of global supply to install enough copper to support a nascent middle-income economy. We first presented this argument in 2014 when Chinese copper demand represented 45% of global demand. Last year, China represented 58% of global demand and we believe there is further to go. For the first four months of 2021, Chinese consumption looks to have grown another 100,000 tonnes and we expect this will continue. Indian demand, on the other hand, was weak in 2020, falling by 95,000 tonnes, as COVID disruptions took a larger toll. Over the first four months of 2021, Indian demand stabilized and is running flat. We will continue to monitor the situation but would expect demand to move higher as deferred projects are restarted this year and next.


Most of the research reports, news articles and investor letters we have read recommending copper investments have focused primarily on these bullish demand trends. While we believe the demand side remains extremely bright, we continue to think the next leg of the bull market will come once investors realize the widespread supply challenges ahead.


As we discussed extensively in our 1Q 2021 letter, there has been a dearth of new copper discoveries and mine development capital spending over the past decade. Moreover, since 2000, most reserve additions have come from simply lowering the cut-off grade and mining lower quality ore as prices moved higher. As we argued in our last letter, we do not believe this will be possible for geological reasons (i.e., log-normal grade distributions) this cycle. As copper prices continue to rise, investors will realize new supply is unlikely to come anytime soon. While new projects are coming online in the DRC, Panama and Mongolia, these will only offset depletion at other existing mines, resulting in muted overall mine supply growth. Last year, copper mine supply fell by 80,000 tonnes compared with the year before, driven mostly by Chile. Most of the disappointment was related to COVID-19 mine shutdowns and will likely come back. However, it is interesting to note that supply has been slower to restart than expected. For example, over the first four months of 2021, Chilean mine supply is only up 30,000 tonnes.


Two geopolitical events occurred in 2Q 2021 that could negatively impact mine supply going forward. In Peru, Pedro Castillo won a contested election running on a socialist platform that includes a 70% tax on copper mining profits. Following Peru’s lead, Chile has proposed legislation that would see copper mine profits taxed at 75%. While these new taxes have not yet been enacted, they are quickly gaining support in Peru and Chile the first and second largest copper producing countries. Such legislation would further restrict capital spending and likely lead to supply disappointments in the future.


We continue to recommend exposure to high-quality copper related mining equities. Over the past several weeks, copper stocks have consolidated last year’s rally and have retraced by 22%. This simply presents a more attractive entry point. Despite having found support from generalist investors, we continue to believe the true potential of many copper equities is being overlooked. Copper continues to be our preferred base metal investment and one of our highest conviction themes overall.


To read more on this subject, we encourage you to download the full commentary, available below.


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