A Tale of the Evaporating Copper Surplus and Four Ways to Play It

An article published yesterday by the Financial Post should serve as a reminder of the tangled web of supply and demand the copper market truly is.

The narrative, akin to a high-stakes drama, pivots around an anticipated copper surplus for 2024. This surplus, a shining beacon of plenty, was underpinned by the launch of significant new projects. But alas, the plot thickens with unforeseen twists.

Surprise supply cuts, those unwelcome guests at the market’s feast, have gatecrashed the party. The closure of one of the world’s largest copper mines amid public protests and operational hiccups in others has led to the vanishing of around 600,000 tons of expected copper, . This shocking development could tip the copper scales from the comfortable surplus that was expected next year to a precarious balance, or even a deficit.

Why is this seismic? Copper, the linchpin in our quest to decarbonize the global economy, is vital for the shift to green energy. A deficit in copper could throttle the pace of this transition. The market, which had been lulled into a sense of security by the expected surplus, is now on edge. Prices, though currently stable, are like a coiled spring, ready to jump at the slightest provocation of demand recovery.

In early October an industry think tank, the International Copper Study Group forecast 467,000 tonnes of surplus in 2024. If the recent 600,000 tonnes of cuts stick, the market could flip to a deficit instead, a dramatic u-turn.

Institutions like Goldman Sachs and BMO Capital Markets are now reevaluating their stances. Predictions of a surplus have morphed into forecasts of a deficit. We’re talking a potential shortfall of over half-a-million tons. The copper market is entering a phase of tightening, a stark contrast to the earlier expectations of a surplus.

Global Copper Inventories

Source: Bloomberg

Copper prices, which have been meandering sideways, might soon find a new direction. As we stand at what might be the foothills of the next copper cycle, the implications are clear: disruptions in copper supply aren’t just a blip on the radar. They are crucial cogs in the global economic machinery, capable of shifting the balance from surplus to deficit, impacting everything from green energy initiatives to the very prices we pay.

In summary, the copper market saga is far from over. It’s a tale of surprise, adaptability, and the ever-present reminder that in the world of commodities, the only constant is change.

When it Rains it Pours

In commodity markets, supply disruptions always seem to happen all at once. A union strike in Panama hits the newswires incentivizing strikes elsewhere in the world. 2023 is turning into a perfect example of how uncertain supply forecasts can be from year to year.

Originally, a copper surplus of 467,000 tons was forecasted for 2024, yet unforeseen supply disruptions have dramatically altered this scenario in record time.

Notably, the Las Bambas mine in Peru, producing about 2% of the world’s copper, closed in early February due to protests, though the mine reopened shortly after and is still on track to produce a record amount of copper this year. Still, Las Bambas reminded investors how fickle commodity supply can be in emerging markets.

Additionally, recent setbacks at other mines, including Anglo American’s Los Bronces mine in Chile and First Quantum’s Cobre Panama mine in Panama, have now contributed to an estimated loss of around 600,000 tons of copper on a go forward basis.

These disruptions have raised the specter of a market deficit, potentially causing significant price volatility and impacting global copper-dependent initiatives, especially in the green energy sector.

Three Ways to Invest in a Copper Shortage

Given the significant inventory shortages coming soon, copper prices are poised for significant gains in the near, medium and long term.

We prefer three different ways to invest in these trends, bucketed by diversification and risk.

Lets start with two underfollowed small caps with significant leverage to rising prices. These names both have truly unique copper assets that allow one to generate the best yield in the industry with below average risk while the other is potentially the most attarctive takeout target for a copper major. looking for high-grade growth.

Hot Chili Limited (TSXV:HCH, ASX:HCH)

Hot Chili is one of those upstart copper players poised to replace supply from struggling South American mines.

We are highlighting the company due to its deep discount to the value of its major project, Costa Fuego, fully funded development and drill program, large resource and backing from mining giant Glencore which means Hot Chili is already on the major’s radar as a potential takeover target.

Hot Chili’s Costa Fuego project is the third largest copper resource in Chile not owned by a major mining company. Costa Fuego is at a low elevation, close to the ocean for export, which means it has a cost advantage over other projects at higher elevations and with questionable water access.

Costa Fuego Resource vs Other Global Projects

Source: Hot Chili Investor Deck June 2023

The current preliminary economic assessment puts the post-tax net present value at US$1 billion at a copper price of $3.85/lb compared to a current market cap of only US$122 million.

And most mining analysts expect closer to $4.00/lb copper over the next five years. The upside potential from lagging supply is far higher than the downside, judging by the estimates below.

Analyst Expectations for Copper Prices

Source: Hot Chili, Bloomberg Estimates

At a copper price of $3.85/lb or greater, Hot Chili will be generating significantly more EBITDA and free cashflow than the market is currently giving them credit for.

Based on the company’s cashflow estimates below, Costa Fuego would generate free cashflow equal to more than 2x the current market cap every year.

Costa Fuego Copper Sensitivity

Source: Hot Chili Investor Presentation June 2023

Hot Chili recently closed a royalty deal for US$15 million that will fund a 30,000 meter drill campaign plus operations for the next 12-18 months. The drill campaign could expand the resource at Costa Fuego and will be instrumental a coming resource estimate upgrade scheduled before the end of 2023.

Hot Chili owns one of the few projects ready to provide near term, large scale copper supply to a market that can’t get enough. Trading at a ~70% discount to the project based valuation of major mining peers, Hot Chili offers significant upside potential with a strong balance sheet and the backing of a major global mining operator.

The fact that a recent North American roadshow in the summer drove the stock up 25%, gives us confidence, Hot Chili is an underfollowed name among both mining and generalist investors, meaning it won’t take much good news to close the large valuation gap to other miners.

Hot Chili Trades at a ~70% discount to Peer Projects

Source: Public Reports, Hot Chili Estimates

Amerigo (TSE:ARG) – Dividend Income with Leverage to Copper Prices

Amerigo (TSE:ARG) is one of the most attractive names in the copper mining sector, a company with strong leverage to copper prices and the highest dividend yield in the sector at ~9%.

Amerigo produces copper without a copper mine, they recover copper from tailing waste streams at Chile’s largest copper mines. They process the waste to recover the copper along with molybdenum – the concentrate product they produce is the same concentrate produced by traditional mines.

Amerigo isn’t a mining company, their core business proposition is a better analogy with a wastewater treatment company. The real differentiator is that a wastewater plant gets a flat fee, while Amerigo gets full leverage to the copper price.

Amerigo has minimal sustaining capex requirements and therefore can focus on return of capital to shareholders. The company has three tools they utilize for their capital return policy: quarterly dividends, performance dividends and share buybacks.

Amerigo’s unique value comes from its peer leading dividend yield. The current 9% yield puts it ahead of all but 1 of the highest yielding companies in the S&P 500 and well above the 1% yield of the Russell 2000. Amerigo even yields more than the average high yield bond at 7.9%, even though the company is in a net cash position, putting its credit quality far above high yield.

On top of the dividend, Amerigo has been aggressive in buying back stock when copper prices are above $4/lb. In 2022 the company bought back 21 million shares over a 12 month period generating a total yield for shareholders (both buybacks and the dividend) of over 20%.

Amerigo’s base dividend is well supported. Management previously guided that at a $4.00/lb copper price, Amerigo should generate free cash flow that covers the diviend by 1.2x. Even at recent lower prices Amerigo reiterated the dividend is safe and a very important investor incentive.

Southern Copper (Ticker: NYSE:SCCO)

Moving up in market cap, our third preferred way to invest in copper upside is to own a high-quality large miner like Southern Copper (Ticker: SCCO). Southern Copper has a market value of $65bn and generates almost 80% of revenue from copper.

Southern Copper Footprint

Source: Southern Copper Investor Website

Yes, Southern Copper is more expensive than large mining peers like BHP or Freeport-McMoRan, but it has outperformed them significantly this year due to its heavy copper weighting.  Exactly the exposure and outcome an investor would want.

Forecast EV/EBITDA in 2024

Source: YCharts

YTD Performance

Source: YCharts

Copper Miner Index (NYSE:COPX) 

And finally, on the lower risk end of the spectrum is the Global X Copper Miners ETF (Ticker: COPX). The ETF is well diversified with 51 positions, and the top 10 stocks taking up a little over half of portfolio.

The diversification of COPX helps you avoid taking on company risk, the risk that one company does something stupid. COPX provides exposure to the price of copper with the potential for better returns than physical copper given the operating leverage copper miners have to the underlying commodity.

Top 25 Holdings of the COPX Copper ETF

Source: Ycharts

Year-to-date copper miners are outperforming physical copper, especially in the last few weeks, showing investors are waking up to the potential upside in copper prices and the leverage you get from owning the producers over the commodity.

YTD Performance of Copper vs COPX ETF

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Capital 10X hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.

Duane Hope is a Partner at Capital 10X, he brings over 15 years of communications and research experience to the firm. His research and writing have appeared in publications for North American, European and Asian audiences.


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