Copper prices are back below US$4/lb – and that's a problem for ASX copper stocks

In the past five months, we've seen copper make a full round trip from US$4/lb to record highs of US$5.2/lb and now it's back below the four handle.

The tumultuous global selloff of risk assets as well as subdued data from China and the US have hammered prices.

Last week, weaker-than-expected US jobs and manufacturing data prompted Goldman Sachs economists to raise their forecast of a US recession within the next year from 15% to 25%.

Meanwhile, China's manufacturing activity slumped to a five-month low in July as factories faced falling new orders and low prices. From a copper-specific standpoint, China's copper inventories have been soaring and suppliers have been offloading excess copper supply into neighbouring LME warehouses in South Korea and Taiwan, signalling potential further price weakness.

"Stockpiles of the metal held in Shanghai Futures Exchange warehouses ended last week well above 300,000 tonnes. That’s not the biggest volume ever, but it is the most for any end-of-May date on record," Bloomberg reported.

Beyond the obvious relationship between copper prices and miner valuations, there are two key issues affecting ASX-listed copper stocks.

#1 Copper stocks are priced for higher prices

While I'm not a fan of broker target prices and ratings, I find the models that support their valuations to be pretty important.

For example, Goldman Sachs (as of 29 July 2024) was NEUTRAL rated on Sandfire Resources (ASX: SFR) with a $8.50 target price. Their model included the following assumptions:

Likewise, Citi (as of 25 July 2024) was NEUTRAL rated with a $8.90 target price and the following assumptions:

The models indicate solid earnings over the next three years as the company navigates peak CAPEX commitments and starts increasing production. However, the most crucial assumption is that copper prices will rise to US$5/lb.

If the bullish outlook for copper falters, it will create a domino effect in the models, leading to lower copper price assumptions, reduced earnings, and ultimately, a lower target price.

#2 The smaller players are struggling

The past 12-24 months have been challenging for small-cap copper producers like Aeris Resources (ASX: AIS) and 29Metals (ASX: 29M) amid soaring cost inflation and adverse weather events. These two have a lot of work cut out for them to lower production costs.

In March 2024, 29Metals suspended production at its Capricorn Project following an extended period of rainfall. Macquarie analysts noted on March 27th, "29M has a difficult pathway ahead with a leveraged balance sheet, required transformations at Golden Grove, and the need for a new strategy amid leadership changes."

In the June quarter, 29Metals had a net debt position of $136 million compared to its current market cap of $250 million. During the same quarter, Golden Grove reported C1 costs of US$4.46/lb and an all-in-sustaining cost (AISC) of US$5.64/lb.

Aeris Resources is also a leveraged miner, with a net debt position of approximately $15 million. The company reported AISC of A$5.23 (US$3.43).

A lower copper price will render these small-cap miners unprofitable and in dire need of more capital to fund ongoing development and their balance sheets are already heavily leveraged.