Green Energy, Low Supply to Drive Copper Prices

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Daniel Greenspan, CIBC Asset Management, senior analyst and resource team director.

Copper prices moved mostly sideways for the past six months, albeit at a very strong level. We’ve seen the price mostly bounced between $4.20 a pound and $4.50 a pound, since June of 2021 as supply has struggled to keep up with demand growth, and as global inventory levels remain low.

Looking forward from here, we believe the outlook for the red metal remains constructive, both supply and demand factors to be supportive of the price. Firstly, on the supply side, while there are a couple of large-scale projects coming closer to first production and ramping up now, there isn’t much in the pipeline for new development after that. We expect the market will absorb the new supply coming, and then enter a period of limited growth, as the sector has under invested in exploration and development for a number of years.

At the same time, growing inflation, and higher political risks in key copper producing regions, like Chile and Peru, will limit investment in new projects, therefore capping the upside in supply over the medium term.

On the demand side, we note that China’s currently entering a fiscal and monetary loosening cycle, with copper prices already at higher levels. Typically, China easing cycles are associated with growing demand for copper. And with low global inventory levels to start and limited supply growth expected, we believe China easing will be further supportive of the price.

Looking a bit further out over the medium term, we believe there’s a case to be made for longer term strength in the copper price, as well. The ongoing transition to a lower carbon energy market will be hugely copper intensive, both on the front end with wind and solar infrastructure, and with power grid upgrades that will be required to deliver the green energy to end consumers. Given this potential new source of copper demand, we expect the supply from new mines will have to be incentivized into production to balance the market. And we believe that a higher copper price will be required to bring the next generation of projects into production.

Turning briefly to a few other commodities in the base metal and bulk markets. We believe the potash market is another commodity that is looking very interesting these days. On the supply side, the market is extremely concentrated with Canada, Russia, and Belarus making up the vast majority of global production. Recent sanctions in Belarus, and the potential for sanctions on Russia, have added material risks to the supply side, for the benefit of Canadian potash producers.

On the demand side, we’ve recently seen Canpotex, which is the Canadian marketing arm for potash producers, sign annual contracts with buyers in both India and China, at strong pricing levels. To us, this signals that buyers have uncertainty around supply from Russia and Belarus. At the same time, pricing in North America, Brazil, and Southeast Asia remain strong, and we believe demand will remain robust into the spring planting season in the Northern Hemisphere.

Next, looking at steel making raw materials, specifically iron ore and metallurgical coal. We believe the outlook here remains constructive as well. On iron ore, the price has been choppy of late, with Chinese regulators clamping down on price speculations. Fundamentally, iron ore should do well, or at least be supported, on China policy easing and infrastructure spending growth that leads to increased yield demand. On metallurgical coal, prices have remained at elevated levels for some time now, and we are entering a period of potential supply disruption with cyclone season approaching in Australia. Similar to iron ore, we expect demand for coal to remain supportive with China policy easing and infrastructure spending and, therefore, steel demand increase.

There are several equities we like to take advantage of the themes we’ve identified. Our top pick is Teck Resources. Teck is a metallurgical coal, copper, and zinc producer with large scale assets in the Americas. The company has one of the world’s largest steel making coal businesses in Canada, a tier one zinc mine in Alaska, and is building a large scale new copper project in Chile.

In addition to the favourable commodity exposure in the portfolio, we also see company specific catalysts in the near to medium term that can drive out performance in the stock. Specifically, Teck is moving towards completion and then ramp up of its QB2 project in Chile later this year, which is expected to be a major catalyst for the company. We’re also watching for the ramp up in consistent performance at their new Neptune port facility in Vancouver. And also see potential this year for a sale of its minority, non-operating state in the Fort Hills oil sand asset, which could be a meaningful catalyst for the company.

Finally, we see potential for a special dividend from the company, which could be announced with its fourth quarter results later in February. At the current stock price, the valuation for Teck remains attractive, for certainly our risks around delivery at QB2, both on CapEx and timing, but we do expect the stock will rerate as the asset gets closer to production and then ramps up.

For more pure copper exposure, we favor First Quantum Minerals, a copper producer with key assets in Panama and Zambia. We believe the market has overestimated the ramp up risks in Panama, and has mis-priced some of the recent political risks the company has faced, both in Panama and Zambia. We see value in the stock over the medium term that we expect to be realized as the company enters into a period of free cash flow generation and deleveraging in a strong copper price environment. For us, the key signpost on this stock is the deleveraging, and as the copper hedge book is rolling off, we expect the balance sheet to strengthen materially in the coming quarters, as the companies will be selling unhedged copper in a strong commodity price environment.

Finally, for exposure to potash, the fertilizer sector, and the agricultural market in general, we like Nutrien, a Canadian-based leader in the sector. Nutrien is a high quality company, with low cost assets, in a diversified production base, that includes a growing retail network. We believe Nutrien is relatively well positioned compared to fertilizer peers. We see minimal capital spending required beyond sustaining capital in the medium term and, therefore, we expect free cash growth, leading to share buyback, dividend growth, and further value-add M&A.