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-- Posted Sunday, 26 September 2010 | | Source: GoldSeek.com
Wellington West Senior Analyst Steve Parsons developed an investment thesis for large copper deposits three years ago. His premise was that competition among Asian smelters would drive these companies to seek guaranteed sources of metal concentrate. In fact, several companies with large copper deposits have either received generous offtake financings or been taken over. In this exclusive interview with The Gold Report, Steve explains his evolving thesis and why it will remain valid for the foreseeable future. The Gold Report: Steve, the copper price has traditionally been considered a bellwether of global economic health. But, more recently, it has remained high despite worldwide economic problems. Why?
Steve Parsons: What has happened is that Chinese copper consumption has remained strong. Earlier in the year, bullish sentiment toward copper was only reluctantly embraced as North American and European economic recoveries appeared tenuous. However, sentiment turned decidedly bullish midsummer as the protracted drawdown in London Metal Exchange (LME) inventories started to resonate with investors and metal traders—particularly when considered with strong Chinese consumption data from growth in the appliance market and social housing projects and improving Institute of Supply Management (ISM) data out of the U.S. More recently, the expectation of more quantitative easing (QE) policies in the U.S. and, thus a weaker dollar, is providing another leg up to copper prices.
TGR: Have we seen the end of copper's economic bellwether status?
SP: I don't think so, just that copper prices may have a stronger correlation with the status of China's economy and that of emerging markets than with the U.S.
TGR: How long do you expect copper to remain in the $3.57 range?
SP: I think there's a good chance it'll stay there for the next few years. In 2011, the market is likely headed toward a supply deficit in the neighborhood of some 400,000 tons. And that's in the absence of strong economies in the U.S. and Europe. If these economies pick up and there is restocking by end users, I think we could see even higher copper prices next year. The prospect of aging mines (i.e., declining grades, deeper and more-expensive mining) and declining production from some of the world's biggest mines could keep average prices at or above current levels through 2013—the point at which some big, new mines come online.
TGR: You mentioned concentrate. When you last talked with The Gold Report, you said "a growing trend spurred by continued tightness in the copper concentrate market has seen Asian smelter groups offer guarantees of low interest offtake financing in return for equity interest in copper concentrate-producing projects and offtake agreements to secure supply." First, please define an offtake agreement for our readers, and then further explain your investment thesis.
SP: An offtake is an agreement signed between a mining company and, typically, a smelter group, whereby the mining company will provide a set amount of concentrate for delivery to the smelter. The smelter charges a processing fee for that concentrate. Most of the big, undeveloped mines are likely to produce a copper concentrate.
What we like about tightness in the concentrate market, as an investment thesis, is that there's a reasonably clear path for investors to make money on copper development companies, irrespective of the weekly and monthly gyrations in the copper price.
Large copper development assets are scarce and largely undervalued, mostly due to project-financing concerns. When I interviewed with The Gold Report last time, we felt that these financing concerns were overblown because there was solid rationale as to why Asian smelters would provide offtake financing as a means to secure concentrate for their smelters in what remained a really tight concentrate market.
What's happening now is, not only are smelters trying to secure long-term supplies of high-quality concentrate with offtake financings; but, because smelting is such a low-margin business, the smelters are also intensifying their efforts to become more fully integrated from the mine to the smelter. That means they're taking equity interests in mining projects. That's going to continue, and development companies stand to benefit from this ongoing theme.
Not only are smelters intensifying efforts to take equity interests, but they're also competing with cashed-up mining companies that are also looking for growth through equity interests in development projects. You've got the smelters and the mining companies competing for a scarce number of high-quality projects.
TGR: Is that how Wellington West determines its coverage? You establish an investment thesis, and then find companies that are best suited to maximize that thesis?
SP: We did in this case. About three years ago, we recognized there was too much smelting capacity chasing too little concentrate and smelter operating margins would get squeezed to the point where it was not a sustainable business proposition. So, the smelter would have to go out and become more fully integrated. As a result, we selectively picked up coverage of companies with large development assets with no offtake deal in place, that are strategically large and not owned or junior ventured (JV'd) by a major.
TGR: Let's go back to what these smelters are looking for in mining projects. What's going to put some projects closer to the top of the list than others?
SP: For early stage development projects, the key consideration for the smelter, other than the strategic size of the asset, is to ensure there's no offtake deal in place for the concentrate. Smelters may also seek out assets where a JV interest can be earned, thereby moving toward a more fully integrated model. Other important considerations are capital-expenditure (capex) intensity, permitting environment and whether or not there's a good shipping lane to China.
Now that's the smelters. The other interested buyers of these development stories are mining companies. They look for the same attributes but, obviously, are less concerned with whether or not there's an offtake deal.
TGR: In these large deposits, there are often other metals—molybdenum, zinc or, in some cases, gold. What happens to the other metals?
SP: Typically, you get the other metals as byproduct credits; but you bring up an interesting point, because these copper porphyry deposits tend to be big and strategic. Not only are these assets coveted by smelters and base metals miners, but the porphyries that have copper and gold are also coveted by gold companies. Gold companies like them because these deposits can provide millions of ounces in gold reserves—the kind of reserves you can't find these days in gold-only assets. TGR: Do you have some parting thoughts on the copper market?
SP: I would say this "offtake thesis" has been a low-risk, high-reward strategy for the past couple years. It's worked out extremely well, and we expect this thesis to persist for the foreseeable future.
Steve Parsons, P.Eng., a member of Wellington West Capital Markets' equity research team since April 2008, is a senior research analyst focused on the mining sector. Wellington West is an institutional equities firm that specializes primarily in the mining, energy and technology sectors. After earning his bachelors of engineering degree in mining at Queen's University, Steve worked as a metallurgical engineer for Placer Dome, and then moved on to a metallurgical consulting firm. Shifting to the investment side of the business after that, he signed up as a research associate with GMP Securities, concentrating on base metals initially and later joined MGI Securities as a research analyst. Streetwise - The Gold Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The GOLD Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.
-- Posted Sunday, 26 September 2010 | Digg This Article | Source: GoldSeek.com
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