CA - JJC: The Copper Bull Case Is Getting Stronger

Summary

• China is rapidly reopening its economy, which is expected to lift up copper demand.
• On the supply side, some major producers are facing issues, exacerbated by political instability.
• I believe the resulting market environment is making the bull case for copper even stronger.

Copper is at the foundation of electrification. With developed economies striving for decarbonization and emerging economies building infrastructure copper demand is expected to grow substantially in the coming decades. But looking in the short-term, in H2'22 copper prices tumbled on recession concerns. Analysts seem split about the market balance in 2023. However, as China is rapidly reopening after a major shift away from COVID-zero policy and is increasing infrastructure spending, demand should pick up fast. At the same time, some of the largest copper producers like Peru are shaken by social unrest. To make matters worse, tightening of the environmental standards and generally hostile attitude towards mining in more and more places of the world is derailing new much needed copper projects. This environment looks quite bullish for the metal even in the short-term.

Expectations for 2023 and beyond

The overwhelming majority of analysts are bullish for copper in the long-term. However, in the short-term some expect weakness, due to global economic slowdown. As such, projections for the 2023 market balance are mixed. For example, BNP Paribas ( OTCQX:BNPQF ) forecasts a surplus of about 1MMt, which is set to decline in the following years. On the other hand, Goldman Sachs ( GS ) sees a deficit in 2023, which is then expected to deepen in the following years.

While both projections point out towards demand overtaking supply in the long-term, the timing is quite important for the short-term moves of copper prices. I'm personally more inclined to Goldman's view, due to China rapidly reopening its economy and mounting challenges on the supply side.

The China factor

China is by far the biggest copper consumer with more than half of the market share. In that regard, Chinese demand is the key factor for Cu prices. As the country was following a Covid-zero policy, economic activity was artificially suppressed, which was one of the reasons for the weakness in metal prices in H2'22. However, now that the Covid-zero policy was abandoned, China is rapidly opening up. This is expected to lift up demand for metals, including copper. Recently, there had been news about the government increasing its fiscal stimulus in 2023. The measures are expected to focus especially on infrastructure development, which is copper intensive. This comes in an addition to the previously announced US$1T infrastructure plan, unveiled in Aug'22.

Meanwhile, despite the restricted economic activity in China, copper inventories of major commodity exchanges were trending lower in 2022, leaving little cushion in case of a demand spike.

Supply challenges

In July 2022, S&P Global came up with an extensive research on the role of copper in the energy transition. The paper outlined the high probability of a market deficit even in the ambitious scenario - which requires significant increase of investment in new and existing projects as well as timely path to production.

The global research and consultancy company - Wood Mackenzie has expressed a view of an even deeper supply gap in the coming decades. The "recipe" to avoid that would again be aggressive investment in new projects and speeding up the permitting process.

I'm quite skeptical regarding the rapid expansion of supply. One reason would be the hostility towards mining of the environmental movement. And this trend is spreading across developing countries as well. For example, in Sept'22, a town in Philippines revoked the permit for Tampakan copper-gold project, which was expected to bring 375k tonnes of copper each year to market. But as this project was yet to be producing, the effects of the ban won't be felt immediately. However, geopolitical turmoil in areas is having more immediate effects. For instance, Peru, which is the second largest producer after Chile has been rocked by civil unrest, following the removal of office of the president. This has led to increased acts of vandalism, including towards copper mines. Glencore's ( OTCPK:GLCNF ) Antapaccay copper mine has been attacked days ago and workers on site had to be evacuated. Needless to say such an environment will disrupt production and reduce supply. Another potential supply disruptions may come from First Quantum's ( OTCPK:FQVLF ) project in Panama, due to a dispute with the government, which may result in the mine being shut down temporarily.

When it comes to more stable jurisdictions with strong property rights like the US, lengthy permitting process is the issue. For example, Taseko Mines ( TGB ), which I wrote about here , has been in the permitting process of its Florence copper project for eight years and counting.

Why JJC

Generally, equities of producers offer leverage to the commodity itself. Of course, there are a plethora of risks associated with this - exploration risk, permitting risk, political risk etc. So for investors with lower risk tolerance, direct exposure to the metal may be a more viable option. One instrument that it offers pure-play copper exposure is the iPath Series B Bloomberg Copper Subindex Total Return ETN ( JJC ).

The data shows that the returns are slightly higher than that of the alternative United States Copper Index Fund ( CPER ). In addition, JJC's expense ratio is also superior at 0.45%, compared to 0.80% of its counterpart. On the downside, liquidity may be an issue for larger investors, especially institutions as average daily volume is around 46.5k shares. However, most retail investors should be okay with that sort of liquidity.

Conclusion

With China reopening its economy and challenges on the supply side, the bull case for copper is getting stronger even in the short-term. Getting Cu exposure through equities, though comes with various operational and political risks. As an alternative, lower risk copper exposure could be obtained through JJC as the ETN offers a relatively low cost way to track Cu prices.

For further details see: