FQVLF - Global X Copper Miners ETF: The Structural Bull Market Is About To Get A Cyclical Boost

2024-01-19 04:37:50 ET

Summary

• Copper prices have been stuck between structural tailwinds and cyclical headwinds.
• The structural support is provided by the growing demand from the energy transition while production disappoints after years of underinvestment.
• Monetary tightening has acted as a lid on the price but that is about to change; both the commodity and copper miners are set for a rally.

Investment thesis

The Global X Copper Miners ETF ( COPX ) has been range-bound for over two years now, after recovering from the pandemic lows:

It has closely tracked the spot copper price which has also been chopping. Copper, as the broader metals and mining complex ( XME ), has been a tale of two competing forces.

On the positive side, we have had three structural trends:

1. Growing demand from the energy transition;
2. Eroding ore grades around the world and decreasing production;
3. Regulatory hurdles that feed into reduced exploration capex.

These reasons probably explain why copper, as one of the most important industrial metals, hasn't crashed despite two years of monetary tightening.

On the negative side, we have monetary tightening and the China ( FXI ) downturn.

I believe the tug-of-war between the structural and cyclical forces explains the chop over the past couple of years. However, as the Fed has already signaled its pivot and China is expected to announce more stimulus, the cyclical factors are about to turn from a headwind into a tailwind.

This is a bullish setup and I wouldn't be surprised if we see new all-time highs for copper by 2025. The COPX ETF tracks closely the metal's performance and is a reasonable way to get exposure to the sector.

The energy transition is a big call on copper

I dived recently into the International Energy Agency's (or IEA) detailed report on the mineral requirements of the energy transition. Copper is not the only critical mineral but is one of the main ones given its role in electrification.

The IEA expects copper demand for electric grids to grow by a factor of 2x to 3x, depending on how quickly the energy transition moves:

The huge expansion of electricity grids requires a large amount of minerals and metals. Copper and aluminum are the two main materials in wires and cables, with some also being used in transformers. Copper has long been the preferred choice for electricity grids due to its high electrical and thermal conductivity...

... Annual copper demand for electricity grids grows from 5 Mt in 2020 to 7.5 Mt by 2040 in the STEPS and to nearly 10 Mt in the SDS. Aluminum demand increases at a similar annual pace, from 9 Mt in 2020 to 12.8 Mt in the STEPS and 16 Mt in the SDS by 2040.

This doesn't include copper's role in battery technology and storage; an electric vehicle, for example, contains about 4 times as much copper as an ICE vehicle.

Overall, copper consumption for 2022 is estimated at about 25 million tons and could grow up to 30 million tons by 2030 on the energy transition's coattails.

Supply shocks are adding to the problem

You would think that in anticipation of a robust rise in demand, producers would be rushing to expand their mining capacity. However, nothing like that is happening, and, in fact, we have seen negative supply shocks.

Mining capex has been in a structural decline :

A big reason for the declining capex has been regulatory and permitting issues as mining is not an ESG-friendly activity - despite its importance for the energy transition. Recently some of the big news in the sector has been First Quantum's ( OTCPK:FQVLF ) shutdown of operations in the Cobre mine in Panama after the government was forced to take action due to strong popular opposition.

More negative production news has piled on. Anglo-American ( OTCQX:AAUKF ) lowered recently its 2023 guidance due to curtailments in Chile:

The downgrade was prompted by weak third-quarter production at its Los Bronces mine, which is located 40 miles northeast of Santiago. The company said that due to a combination of continued higher ore hardness and a substation fire that interrupted plant facilities power supply for 16 days production had fallen at the site by a fifth.

This week the Chilean Copper Commission (Cochilco) also alerted on slowing production:

Cochilco says the drop in production after the peak will be due to the natural aging of mineral grades, a decrease in reserves, and the closure of certain projects with no planned replacement.

As reported by Bloomberg, these supply events have quickly switched the 2024 expectation from a copper surplus to a deficit situation. The Shanghai Metals Market changed its market balance forecast from a 70,000 tons surplus to a deficit of 200,000 tons to 300,000 tons for the year.

The concentrate processing fees charged by Chinese smelters have also been a sign of tightening supply ; these fees drop when concentrate is scarce and the smelters have to decrease their margins to be able to secure sufficient material:

According to a Reuters report :

Chinese smelters were unable to buy enough copper concentrate, with some experiencing passive production cuts due to insufficient operating rates.

In this environment, Ivanhoe's ( OTCQX:IVPAF ) chairman has commented in interviews that the copper price may need to go as high as $15,000 per ton (so about double the current levels) to incentivize investment in new mines.

Monetary policy is turning into a tailwind

I find it remarkable that copper has held up so well with the monetary policy headwinds. We got a glimpse of what may happen in the near future when Fed chairman Powell made his dovish comments around December 13:

And it's not just the Fed; it looks globally rate hikes have peaked :

Lastly, there is much debate if China will increase its fiscal stimulus . Personally, I don't see what other choice their government has. Just like the U.S. or European policymakers, the Chinese ones will eventually do what they have to do.

So to recap, there is accumulating evidence we are about to switch from a tightening into an easing regime in the U.S. and globally. Given how well copper has held during the monetary tightening, I am very bullish on its prospects under easier monetary conditions.

The COPX ETF is a reasonable vehicle

The COPX ETF has decent exposure to some of the largest copper miners like Freeport-McMoRan ( FCX ):

As shown from the chart above, the ETF is highly correlated to the copper price.

In theory, the copper miners should rise more than the underlying commodity due to their operating leverage. However, investors should keep in mind that all-in-sustaining costs (or AISC) will also likely rise. The easier monetary conditions that will be bullish for copper will also increase the prices of the copper miners' production inputs, namely energy, and labor.

Bottom line

Copper is in a structural bull market. Demand is high and growing, fueled by the energy transition. Supply is disappointing due to chronic underinvestment in mining. This is a bullish setup for established players with already-developed assets. Copper has been pressured by the cyclical monetary headwinds, but we are near an inflection point at which monetary policy should turn into a tailwind.

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