Inflation Protection: Hunting for Value Among Copper Miners

Inflation is Back in a Big Way

In the current global economic backdrop there is no bigger risk for investors than inflation – the damage it can cause to someone’s portfolio is very real.

Twitter and Square CEO Jack Dorsey weighed in last week, stating: “Hyperinflation is going to change everything. It’s happening”.

Hyperinflation isn’t a word to be thrown around lightly, it has devastated countries like Venezuela.  The visual below highlights the crisis of runaway inflation, in 2018 it cost 14 million bolivar to purchase a chicken in Venezuela; and a roll of toilet paper cost 2.6 million bolivar.

At the peak of Venezuela’s inflation (January 2019), it took 15 days for prices to double – no economy (developed or developing) can withstand this kind shock unscathed.

Record Central Bank Money Printing is the Kindling for High Inflation

In an effort to combat the economic crisis as a result of COVID-19, central banks globally have significantly increased money supply. In the US, M2 money supply has increased 35% to $21 trillion since the beginning of the pandemic.

Ultra-accommodative monetary and fiscal policy have driven commodity prices higher across the board. The US Spot raw commodity index is an excellent measure of underlying inflation in the economy as it excludes energy and food, its current 13 components are: burlap, print cloth, tin, copper scrap, rosin, wool, cotton, rubber, zinc, hides, steel scrap, lead scrap, and tallow. It is the oldest of all indices measuring commodity prices, with the data series going back to 1934.

As a result of the higher costs of goods and services, consumer expectations for inflation have begun to surge, the one-year ahead expected inflation rate the U.S. is now 5.2%, the highest in the history of a data series that goes back 8 years.

The 1970s are the best proxy for the current inflationary episode. During the 70s the best way for investors to protect themselves versus inflation was by owning gold (30.7% annual return) and commodities (24.1% annual return); we believe that applies to this decade as well.

Copper is in the Sweet Spot for Commodities

Copper is one of the most critical commodities for the future green economy; it is a key input for electric vehicles, wind, solar and infrastructure.

Goldman Sachs has declared copper the new oil, they projected green related copper demand will increase from 1Mt in 2020 to 5.4Mt in 2030. This green demand currently represents 3% of total global copper demand, by 2030 it will be be close to 16%.

Copper is one of the best performing metals in 2021 having risen 25% year to date.  We believe we’re still in the early stages of a commodity bull market and that copper will be front and center – there’s still significant potential upside ahead.

Commodities are the cheapest they have ever been relative to US equities in the last 50 years.

During this half century commodity bear market there was very little price incentive for new capital spending. US private investment in mining exploration has fallen from $500 billion at the previous peak of the commodity boom (1980) to $50 billion today.

Given this low level of investment, the copper market is setting up to be in a large deficit position relative to supply post 2025. Current global mine production and projects in development simply can’t keep up with the strong demand.

Hunting for Value Among Copper Miners

Small & Mid Caps Primed for M&A

This is a very attractive structural macro environment to invest in copper miners, we screened the producer universe for value.

Small & mid cap copper producers are trading at steep discounts relative to large cap producers on every valuation metric. Small & mid trade at a 62% discount on forward price-to-cashflow, 39% discount on forward EV/EBITDA and 43% discount on forward price-to-sales.

Given that large cap valuations are nearly double that of small/mid producers, M&A is one of the most tangible ways for large caps to grow production and enhance shareholder value.

We believe we are on the verge of entering a prolific M&A boom in the sector and investors would be positioned for the most upside by owning small & mid cap producers.

Small & Mid Cap Copper Value: Sierra Metals, Nevada Copper & Hudbay Minerals

Sierra Metals (NYSE:SMTS, TSX:SMT), Nevada Copper (TSX:NCU) and Hudbay Minerals (TSX:HBM) trade at deep valuation discounts relative to their small & mid cap copper peers (which are already very cheap vs. large caps).

Large Cap Copper Value: First Quantum & Lundin Mining

Given the steep discount of small & mid cap copper miners, we believe exposure to large cap copper miners should be muted relative to small & mid cap. However within the group, First Quantum (TSX:FM) and Lundin Mining (TSX:LUN) screen most attractive.

Sierra Metals is a market awareness client of Capital 10X.