Why copper's long-term outlook is getting hard to ignore

Copper has a wall of worries to climb before it can reach a promised land where the market is in a clear-cut deficit, the commodity is priced like a battery metal and miners return to profitability.

It’s the near-term volatility that makes the copper trade so difficult. And things have been even more challenging on the listed front – With names like Sandfire Resources (ASX: SFR), 29Metals (ASX: 29M) and Aeris Resources (ASX: AIS) facing a myriad of operational and financial challenges.

Nobody wants to hold a stock through an ugly drawdown, so how do investors navigate the near-term uncertainty to capitalise on the long-term opportunity?

In this wire and with the help of Tribeca Investment Partners' Todd Warren, I'll be taking a look at the copper story so far, the problem with copper miners and the state of play for ASX-listed names.

The Story So Far: Spot Prices Have Gone Nowhere

The copper we know right now is not exactly the one investors typically associate with monstrous demand from megatrends like decarbonisation and EVs. If it was, prices wouldn’t be unchanged in the past two years and down 15.9% in the past twelve months.

Copper price chart (Source: TradingView)

Copper remains the humble Dr Copper, a bellwether of economic activity with an acute sensitivity to the ebbs and flows of industrial demand.

“The market is still heavily dominated by macro events and with that as a backdrop, it’s difficult to fire all your bullets at once,” said Warren.

UBS reiterated similar views on Thursday, saying that the “risk vs. reward for copper is improving and the medium-term outlook is constructive.”

"We now forecast only a modest surplus in 2023, moving to a growing deficit from 2025. In our opinion, this increases the risk of material price upside over the next 2-3 years (potentially copper's 'lithium moment')," the analysts said.

"However, we do not have conviction we have reached the bottom of the cycle and as a result our global recommendations on copper equities generally remain cautious."

But at what point should investors start to take copper seriously?

“Copper is a fairly asymmetric trade,” said Warren, adding that “there are some potential headwinds in the immediate term but a lot of that’s already priced.”

The problem with copper stocks

It ain’t easy being a copper miner – Alongside industry-wide cost inflation, the ore grades at many copper mines are decreasing, which means miners need to extract more to produce the amount of copper.

In 2019, the average copper ore grade at global copper mines was 0.62%, down from 0.71% in 2010, according to the World Copper Factbook.

“Everyone’s looking at copper from that long-term perspective but forgetting about the point that cost curves have all risen dramatically. The third quartile of the cost curve is around US$3.50 a pound,” said Warren.

Let’s look at three examples below:

Oz Minerals was acquired by BHP earlier this year for $9.6 billion. If you look at how Oz Minerals performed in FY22 – Getting bought out might seem like a pretty sweet deal, at least in the short term.

Oz Minerals posted net cash outflows of $78.9 million in FY22. To break things down:

• Operating cash flow: $647.6 million

• Investing cash flow: -$951.0 million

• Financing cash flow: $224.5 million

• Net cash flow: -$78.9 million

The investing outflows reflected:

• Carapatenna plant, equipment and mine development costs: $358.3 million

• Prominent Hill development: $235.5 million

• West Musgrave costs: $165.9 million

So when exactly is BHP going to make its money back?

The narrative is very much the same for Sandfire Resources – which posted cash outflows of $188.4 million in the first-half of FY23.

As well as 29Metals – Its 2023 guidance has costs totalling more than $1 billion. Whereas the company generated $720.7 million in revenue in 2022.

In a world where ‘cash is king’ – Why would investors want to invest in a copper play that can’t even generate positive cash flow?

Copper speculation: Net short

Copper is also a speculative asset where factors such as positioning and sentiment can exacerbate changes in market prices.

“The market was caught short when China made an about-turn on their reopening policies in January this year,” notes Warren.

“And so the market raced into trying to get exposure.”

Copper prices (December 2022 - February 2023)

“Could the copper price go lower from here? Of course it could, but a lot of that money’s already positioned for that. So where’s the marginal dollar going to go?”

“That’s where I’d be cautious being excessively bullish right now, but the longer-term thematics are going to be difficult to ignore because there is just not enough money going into new supply.”

ASX-listed picks: A small cap of interest

I asked Warren about his views on the two remaining large cap ASX-listed copper options: Sandfire Resources and 29Metals.

“The removal of Oz Minerals from the market has been somewhat of a blessing for Sandfire and diverted some of the negative attention away from the stock and drawn attention to the growth prospects and the fact that it is the only relatively large and liquid pure play that Australian investors can get,” says Warren.

“They’ve been through a management change and in the throes of turning on their Botswana asset - Motheo. And the jury is out on whether they are through the woods with the MATSA assets in Spain.”

Despite Sandfire's bumpy ride with MATSA and volatile copper prices, the stock is up 3.9% year-to-date and 4.2% higher in the past twelve months.

Sandfire Resources 12-month price chart (Source: Market Index)

29Metals has been in deep water and you only need to go as far as its share price performance (down 65% year-to-date) vto understand the magnitude of its problems. 

The market is currently concerned about the additional capital required to restart production at its Capricorn Project and unlock growth. The risk of a capital raising is real. Very real.

“Their big shareholder probably doesn’t want to dilute at these levels. But by the same token, I think it’s pretty clear that they will need some extra capital on their balance sheet. I think they will most likely have to come to the equity markets,” he said.

When it comes to the smaller end of town, Warren preferred AIC Mines (ASX: A1M) – A $180m market cap producer that owns the Eloise copper mine in North Queensland.

“It’s run by a very capable management team including Managing Director Aaron Colleran, who’s ex-Evolution (ASX: EVN). Evolution was built through acquiring smaller assets and consolidating that into a greater beast. They’ll do the same for AIC.”

“The market still needs some convincing but we do think they’ve got the right team and a strong balance sheet.”