The Red Metal Rides Again
07/12/2012 9:00 am EST
Don’t get lost in the turmoil of Europe and miss the resurging opportunities in China, suggests Roger Conrad of Global Investment Strategist.
Greece is a small country with huge problems. As Global Investment Strategist editor Yiannis Mostrous has been reporting from his home country, these problems are far from resolved, and their spillover effects are substantial.
What’s worse, several larger European economies are starting to follow the same troubled path. Notably, Spain has now requested a bailout of its major banks.
However, investors should not let Europe’s woes overshadow increasingly favorable developments in China. Chinese copper demand should expand in the second half of 2012, as the country’s aggressive measures to stimulate its economy raise consumption of the metal.
In recent weeks in this publication, Yiannis has repeatedly emphasized that China is much stronger than the investor consensus would have you believe. Now that China’s leaders have tamed inflation fears, they can focus once again on the country’s still-immense needs for infrastructure, including ports and shipping facilities.
Infrastructure currently represents about 20% of China’s total fixed asset investment, and the government is getting ready to fire up spending even more. This fiscal stimulus will revive demand for a range of raw materials needed to build and maintain facilities. This demand dropped over the past year, but is still strongly positive.
Growth in Chinese demand for electricity, for example, accelerated in May from April and will apparently grow again this month. Output of “long steel” products rose a solid 8% in the first quarter of 2012 versus year earlier levels, despite the government’s effort to control growth.
How important is China to global demand for natural resources? That depends on the commodity. But there’s no doubt of its overwhelming dominance of the global market for copper, in large part because of mushrooming demand for electricity as part of urbanization.
The country’s copper consumption expanded at a 10.1% annual rate from 1980 through 2010, exploding to a 40%-plus share of total global demand. That’s up from barely 6% as recently as 2002. In fact, China’s copper usage is more than 10% greater than consumption in Europe, the US, and Japan combined.
Copper prices are currently down about 25% from early 2011 highs, largely on concerns Chinese copper demand will shrink over the next year. That’s at least partly based on the drop in a widely watched measure of Chinese industrial activity.
But it’s gainsayed by reports from major exporters such as Chile’s state-owned Codelco, which ships 53% of its output to the world’s most populous nation, and expects copper exports to be at least 5% to 6% greater this year than in 2011.
Assuming Chinese demand rises only that fast, it would consume an additional amount of copper sufficient to offset a 15% decline in European demand. It would also offset a more than 25% drop in US demand. Since such extreme drops in demand elsewhere are unlikely, the upshot is Chinese demand growth will power another year of rising usage, and a recovery in copper’s price.
Several stocks in our Metals and Mining Portfolio are major producers of the red metal. All of these stocks have weakened in the past 12 to 18 months, as copper prices decline and mining stocks as a whole lag the prices of the metals they produce.
We sold Xstrata (London: XTA), in anticipation of a merger with its 34% owner Glencore International (London: GLEN) back in April. That deal now appears to hang on whether or not Glencore management can appease dissident Xstrata shareholders, which is likely to require some combination of a higher offer (currently 2.8 shares of Glencore for each Xstrata share) and a cut in planned post-deal payments of $270 million to Xstrata executives. Xstrata shareholders are scheduled to vote on the deal July 12.
At this point, it seems likely Glencore will bend, creating a global production and marketing powerhouse for a range of resources including copper. We still recommend buying Glencore American Depositary Receipts up to $14.50. In contrast, failure of this deal could send Xstrata shares plunging, so we’d still avoid that stock.
Teck Resources (TCK) has also made a major bet on copper. During the company’s first-quarter conference call last month, CEO Donald Lindsay stated its copper business “has the highest growth potential over the next five to seven years,” rather than its Canada-leading metallurgical coal and zinc businesses.
Teck expects to ramp up its copper output to better than 400,000 tons a year in the second half of 2012, from a rate of just 322,000 tons last year. Despite this promise, the stock is down nearly 18% this year. Teck’s a solid buy at much higher prices.
Finally, BHP Billiton (BHP), Rio Tinto (RIO), and Vale (VALE) are far from copper pure plays, and their stocks are likely to be more affected by iron ore prices this year. All are nonetheless major producers of copper as well and will benefit from any rebound in coming months.
Each of these stocks trades at a bargain price. Buy BHP Billiton up to $100; Rio Tinto up to $60; and Vale up to $40. Meanwhile, our most direct bet on copper is Freeport McMoRan Copper & Gold (FCX).