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Stefan Ioannou: Bottom-Fishing Opportunities in Base Metals, Especially Zinc

 -- Published: Tuesday, 3 February 2015 | Print  | Disqus 

Source: Brian Sylvester of The Mining Report 


Copper is off to a rough start in 2015 and while other base metals have also shown price weakness, zinc could finish 2015 strong, says Stefan Ioannou, mining analyst with Haywood Securities. He estimates that over the previous two years about 12% of global zinc production ceased and more will end soon, ultimately leading to a run in the zinc price in late 2015 and into 2016. In this interview with The Mining Report, Ioannou tells us how to follow zinc's path to big portfolio gains.



The Mining Report: Copper has fallen about 12% in 2015 and other base metals are seeing significantly weaker support after the World Bank said it expects the global economy to slow by as much as 1% this year. Is the bull market for commodities over or is this a pause in an otherwise bullish cycle?


Stefan Ioannou: Looking at this market as bullish over the past couple of years may be a bit aggressive. There has been a cautious tone since 2012. Metal prices relative to historic prices are definitely higher, but so are operating costs. The margins haven't changed much. Depending on the metal you're talking about, there are also concerns about large surpluses and global economies possibly slowing down.


TMR: Would it be fair to say that while base metal prices may be under pressure in a broad sense, specific equities may have catalysts or other news that could offset commodity price weakness?


SI: Well-run companies tend to do well, assuming they have a project that can demonstrate reasonable economics in a given pricing environment. However, in mid-January we witnessed a massive correction in the copper price—a lot of value has been taken off the table. When there are rapid drops like that it almost doesn't matter how great a project is. In the short term those companies will face general market sentiment, which tends to hit the panic button and exit the resource sector en masse. That reaction was probably overdone in terms of the response of the equities and their valuations. There is a bottom-fishing opportunity there.


TMR: What was the general sense at Haywood when you watched those corrections occurring?


SI: We tried to determine if a specific event caused copper to test and break the $2.50 per pound ($2.50/lb) support level and the simple answer is no. There's obviously some well-founded concern about global economies. When the oil price took a nosedive in Q4/14, that put all the commodities under the magnifying glass. Copper, essentially the master of the base metals, has been hit hardest.


TMR: Please give us your revised price decks in light of recent events.


SI: We're seeing $2.50/lb copper right now but there is room for the copper price to go lower. That is the market sentiment. Haywood's recently revised formal 2015 price is $2.50/lb, essentially in line with current spot pricing. Volatility aside, we anticipate the price will moderate around current levels this year. Our long-term outlook remains more bullish, underpinned by a formal forecast price of $3.25/lb. This is a cyclical market. In a couple of years we're going to deplete surpluses, and the cycle is going to turn.


TMR: What are your near-term and long-term prices for zinc and nickel?


SI: Our formal zinc price for 2015 is $1.10/lb, which is a notable move up from where it is right now, at just below $1/lb. The zinc market is an interesting space. Current inventories are still quite high, but they're being drawn down rather quickly. We have seen and are in the process of seeing large zinc mines shut down.


Over the last two years or so we've lost about 12% of world production and the advanced-stage projects slated to replace those mines are quite few—not enough to replace what we're losing. We are anticipating a move in the zinc price, probably later this year. Then in 2016 and 2017 we could see zinc prices really run, as in 2007, when zinc rose to $2/lb. Any company with zinc in its name or zinc in its business plan stands to do well. Looking further ahead we anticipate higher pricing will prompt more production, in turn moderating the market. Hence, we continue to use a long-term zinc price of $1.15/lb.


TMR: And nickel?


SI: Nickel is somewhere between copper and zinc. In 2014 we saw the Indonesian government enact a nickel export ban, which had notable market consequences. A lot of nickel has been taken off the table, which would have otherwise caused a surplus. There are rumblings as well that the Philippines may follow Indonesia's lead. It may not be an outright ban on nickel exports, but higher taxation is possible. The nickel market has come under a bit of a squeeze. We could see global nickel supplies switch from surplus to deficit by as early as mid-2015. That would be a major trigger point for nickel prices moving higher. For 2015 we are using $7/lb nickel. Our long-term price is $9/lb.


TMR: Many of the base metals equities you cover are sensitive to even small commodity price swings. How do you account for a weaker base metal price environment in your 2015 equities investment thesis?


SI: We have to be cognizant of volatility in general. Massive swings on the order of $0.10 to $0.20/lb in a day have huge implications for the underlying equities that trade on multiples of the copper price. The general sentiment is that prices are going lower before they move higher, so you really want to stay away from leveraged plays. What makes a company leveraged? In general, the lower-grade mines are typically the higher-cost mines. That higher cost translates into more leverage. Small moves in the copper price, for example, have a significantly greater impact on a high-cost miner's profitability. You want companies with higher-grade mines and lower cash cost structures so that their profitability isn't adversely affected by swings, i.e., drops, in the copper price.


Another important piece to look at is declining cash flow from producers as a result of declining metal prices. If there's any debt on the balance sheet, you want to be sure that these companies are going to generate enough near-term cash flow to service that debt.


TMR: Is cash flow what investors should be most mindful of as they invest in base metal equities?


SI: Yes, cash is king. The balance sheet should always be something that's looked at in detail, but especially when we're getting into a significantly lower metal price environment than anyone anticipated even three months ago. A company that was generating significant free cash flow at $3/lb copper could be a drastically different story at $2.25/lb copper.


TMR: You recently made a presentation at the Vancouver Resource Investment Conference. Please share some highlights with us.


SI: I talked about the outlook for zinc. As I said before, there are large inventories but about 10% to 12% of world supply has either stopped production or is ending soon and the list of projects to replace those mines is almost nonexistent. The market is definitely shaping up for a swing from surplus to deficit. The exact timing remains to be seen, but most estimates are showing the actual inventory pinch point hitting as early as the beginning of 2016.


My guess is that market anticipation will prompt equities to move sooner than that, probably in the second half of this year. At that point we could be off to the races on the zinc price. Keep in mind, however, that mining is a cyclical business and if we do see higher prices it's going to prompt new production, namely out of China. Nevertheless, the zinc story appears to be shaping up to be a potentially interesting trade to keep in mind.


TMR: Thank you for your time and your insights, Stefan.


Stefan Ioannou has spent the last eight years as a mining analyst covering mid-cap base metal companies at Haywood Securities. Prior to joining Haywood, he worked with a number of exploration and mining companies, as well as government agencies as a field geologist in Nevada and throughout the Canadian Shield in both the gold and base metal sectors.


1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor.
2) Streetwise Reports does not accept stock in exchange for its services.
3) Stefan Ioannou: I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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