Copper Prices Not Reflecting Positive Medium-Term Outlook

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By Chris Shaw

Copper has proven to be very resilient over the past few months, as while the outlook for global growth has worsened and investors have become more risk averse the copper price has only lost about 20%.

While these pressures suggest some more potential downside for the metal price, Deutsche Bank expects strong buying support may emerge at the US$5,500-$6,000 per tonne level. This view is based on a number of factors, one being the physical copper market remains tight. This means any extra tonnages appearing in exchange warehouses are expected to be modest.

As well, Deutsche's view is Chinese buying remains at elevated levels, which is relevant as the price arbitrage between the London Metals Exchange (LME)/Shanghai Futures Exchange prices is a key supporting element for LME pricing.

Even allowing for the possibility of a double dip recession in the Western World, this is unlikely to be significantly bearish for copper prices according to Deutsche Bank. While China has seen some de-stocking of the metal of late, any similar de-stocking of the metal in the west resulting from such a downturn is likely to be very modest.

This is based on Deutsche's view ongoing credit constraints and limits to the physical availability of the metal have made it tough for manufacturers to lift stocks to normal levels. In other words, there is little available metal to de-stock.

Financial capital should continue to be important for commodities and this applies to copper as well. Deutsche notes the introduction of an Exchange Traded Fund (ETF) for aluminium later this year may lead to similar ETFs for other metals including copper.

In Deutsche's view the market is already adopting a relatively bearish outlook for metal prices generally and copper specifically, but this is potentially ignoring some of the factors that could limit downside risk for the metal. This is especially the case given the considerable potential for inflation to pick-up going into 2011.

Given such an outlook, Deutsche Bank is forecasting average LME cash prices for copper this year of US$6,744 per tonne and in 2011 of US$7,714 per tonne. In 2012 Deutsche is forecasting an average price of US$8,816 per tonne.

National Australia Bank is also positive on the medium-term outlook for commodity prices, expecting further consolidation in the next few months before re-stocking in Asia and a demand recovery in the developed world pushes up prices late this year and through 2011.

As the bank's Australia and commodities economist Ben Westmore notes, weekly LME data shows copper stocks have now declined for 16 weeks in succession. This implies further tightening in the physical market.

Cancelled warrants for copper have also risen since the beginning of this year, which Westmore notes is indicative of a rise in usage and further falls in inventory levels. On the supply side, DanskeMarkets notes both Chilean and Chinese output is struggling to rise, which suggests it will be difficult for global supply to increase at current price levels for the metal.

The combination of a tight market and limited upside to supply potential are positives but at the same time Danske suggests there are also few signs of improvements on the demand side. This means on the group's fair value measure copper prices have been overvalued for most of this year.

But the important point is the model doesn't take future supply issues into account, so Danske is actually more positive on the outlook for copper prices than is the market is present. Danske's forecasts call for average copper prices of US$7,300 per tonne this year and US$8,400 per tonne in 2011, which are down slightly from previous estimates of US$7,500 and US$8,500 per tonne respectively.

In quarterly average terms, Westmore is forecasting copper prices of US$7,162 per tonne for the June quarter, US$7,086 per tonne in the September quarter and US$7,317 per tonne in the December quarter. In 2011 Westmore is forecasting quarterly average copper prices in US dollars per tonne of $7,317 for March, $7,692 for June, $7,808 for September and $7,926 for December.

GSJB Were is of the view copper demand will outstrip supply in 2011 and the market will move back into deficit, making the metal the most attractive of the base metals in terms of fundamentals. The market appears to be focussed on the short-term economic outlook at present, so the broker suggests those with a 1-year plus view of the world will be rewarded for considering copper exposure at current levels.

This offers good potential for corporates looking to expand positions in copper in the view of GSJB Were, as current share prices are depressed despite attractive asset bases. In looking at Australian copper stocks the broker has attempted to calculate what copper price is currently being priced into each company.

For comparison purposes, GSJB Were has estimated the copper price at which its base net present value for each stock equals the current share price. For PanAust ((PNA)) the broker suggests the current share price implies a copper price of US$2.60 per pound, while for Oz Minerals ((OZL)) it is US$1.80 per pound. For Equinox ((EQN)) this rises to US$3.40 per pound, while for Aditya Birla Minerals ((ABY)) the market is factoring in a copper price of US$2.60 per pound. For Sandfire ((SFR)) this rises to US$3.00 per pound, while for Citadel Resource Group ((CGG)) it is US$2.90 per pound.

Adding in a company's resource base and mine life complicates the analysis so while Equinox is the most expensive in terms of what copper price is being factored in at current levels it becomes better relative value when resources are also considered.

From an overall sector perspective, GSJB Were suggests Equinox is the most attractive copper play in terms of scale and mine life so the broker sees it as a potential merger and acquisition target. Smaller scale producers cannot be ruled out though, the broker seeing these plays as appropriate targets for the mid-tier copper producers.

An example is Sandfire, as the move by Oz Minerals may be seen as the first step in a possible takeover further down the line in GSJB Were's view. Overall the broker rates Equinox, Kagara Zinc ((KZL)), Oz Minerals and PanAust as Buys, while it ascribes Hold ratings to Citadel and Aditya Birla.

ASX-listed stocks with exposure to copper include Redbank Copper ((RCP)), Finders Resources ((FND)), Universal Resources ((URL)), Blackthorn Resources ((BTR)), Ivanhoe Australia ((IVA)), Cudeco ((CDU)), Indophil Resources ((IRN)), Pacmag Metals ((PMH)), Anvil Mining ((AVM))
, Sovereign Metals ((SVM)), Discovery Metals ((DML)), Straits Resources ((SRL)), Sandfire Resources ((SFR)), PanAust ((PNA)), Jabiru Metals ((JML)), Exco Resources ((EXS)), Tiger Resources ((TGS)), Kagara ((KZL)), OZ Minerals ((OZL)), Hillgrove Resources ((HGO)), Equinox Minerals ((EQN)), Rex Minerals ((RXM)), Fox Resources ((FXR)), Aditya Birla ((ABY)) and India Resources ((IRL)).

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