Markets & Economy

The copper industry has been in a state of duress for the last several years following the end of the China-driven commodity supercycle. This industry pressure led to pricing declines and supply constraints, but with demand predicted to remain stable, we believe the industry is ripe for a multi-year deficit which presents opportunities for investors.

Given copper’s unique properties of electrical conductivity and anti-corrosion, the refined commodity is heavily utilized within the building and construction markets, along with electrical networks infrastructure, transportation, and industrial machinery and equipment markets. As such, global growth and infrastructure developments tend to perpetuate demand for the commodity.

What Makes Copper Attractive Now

Copper experienced a sustained period of increased demand, largely driven by China’s industrial and urbanization surge beginning in the early 2000s. Industrial growth has since slowed in China, leading to the end of the supercycle and the onset of five years of pain as copper prices sharply declined. This downturn resulted in collapsing returns and profitability within the industry.

Current dynamics in the copper industry led us to view the space as an emerging area of opportunity. One of our bottom-up stock selection strategies is founded upon uncovering companies poised to benefit within depressed industries where we feel there will be disequilibrium of supply and demand. As such, we have recently added exposure to a select number of copper producers in some of our portfolios.

Our View on Supply

The prolonged period of low prices—along with increased balance sheet strain for many miners—has hindered copper project investments, leading to a decline in capital investment for expansion and constraining supply.

Other headwinds to supply include copper scarcity and declining ore grades. Over time, it has become more difficult to find and mine copper, and when copper is found, it is of increasingly poor quality. This raises the cost of delivering each incremental unit of copper, which drives the copper breakeven price higher and presents a secular challenge to copper supply that will continue to exacerbate over time.

Given these challenges, we see slowing supply growth for the next several years, as it takes at least 3-5 years to bring on new copper production after initial construction of a copper project.

Our View on Demand

Global GDP growth plays into the support of copper. We expect to see moderate tailwinds in China remain in place for core areas of copper demand that, even without a step-up in fiscal stimulus, will likely result in continued stabilization in growth. Growth from emerging markets in Asia and Latin America should accelerate as many of these countries have likely reached a cyclical bottom. While growth from developed markets will likely remain slow, another area of demand upside could be stimulated by the U.S. should the Trump infrastructure plan come through. Overall, our estimates are in-line with average historical growth rates, and we anticipate that demand will remain resilient.

Manning & Napier’s Deficit Viewpoint and How it’s Played Out Thus Far

Given the supply challenges, and our expectation that demand remains stable, we believe there is a sizeable multi-year deficit developing. This copper deficit should propel a copper price rebound as the market shifts back into balance. A global recession or significant deterioration in Chinese demand growth that substantially alters the market balance could lead to a delay in a market deficit. These are two key areas of risk we continue to monitor. However, we have already witnessed supply disruption tracking above expectations, an indication our investment thesis is playing out.

Earlier this year, the world’s largest copper mine, Escondida, was shut down for over a month due to a labor strike, and even though operations have resumed, normal production levels are unlikely to be attained before July.

Meanwhile, production was curtailed for over a month at Grasberg, the world’s second largest mine, amid an ongoing dispute with the Indonesian government over obtaining a copper concentrate export permit.

Additionally, the majority of top copper producers lowered production guidance for 2017 during earnings release season. Copper is also poised to benefit from rising interest rates in the U.S., as copper prices often benefit from improving growth.

Our view is founded on our disciplined investment approach, which has led us to companies with high-quality assets, strong production growth profiles, and solid balance sheets to weather the challenging environment. Copper prices are likely to experience volatility over the near-term, but we believe there are a select number of companies with desirable attributes which will place them in a position to benefit from the supply/demand imbalance we see materializing.