A VIEW FROM THE TOP END

Markets:

Our previous update outlined our strategy that would focus more on financials and commodities, as inflation expectations as well as central bank actions continued to steepen yield curves. With the world economy recovering quantitative easing measures that boost asset prices and stoke inflation fears are set to find their way into the cross hairs to be tapered over the next year, a change of positioning was prudent. The AUD fell 1% since the last time we wrote, helping returns for the Nasdaq and S&P 500 from an Aussie investor perspective, as the two indices gained 3.74% and 1.84% respectively. At home, the ASX200 was trimmed 1.40% as iron ore prices dipped from all time highs. Leading the ASX the last two weeks were the health sector (+3.53%), consumer staples (+1.78%) and financials (+1.46%). Laggards on the ASX were materials (inclusive of mining -7.82%), utilities (-4.20%) and energy (-4.04%).

Mining - Copper:

A little while ago we did a piece on iron ore that was well received. Materials are a large part of our investment framework as well as Australia’s recovery story from the ongoing pandemic. This week we felt that a deep dive into copper would be beneficial.

Copper (“Cu”) itself has an amazing array of properties that makes it valuable. It is the best non-precious metal conductor of heat and electricity, it is ductile making it easy to work and shape, it is easily recycled as you can remelt it endlessly with no loss, and finally it is mostly unreactive, taking ages to interact with the atmosphere to oxidize. These properties make copper perfect for use in appliances and electronics (31% of market), construction (30% of market), infrastructure (15% of market), automobiles (12% of market) and industrial uses (12% of market). Copper is everywhere in our lives, a good example would be the average Australian home has 180kg of the metal tucked away in wires, air conditioners, plumbing, computers, mobile phones, televisions, and other appliances.

The entire world consumes roughly 24 million tonnes (mt) of copper per year. To put this into contrast iron ore is a behemoth at nearly a 1,900mt market, the second most used metal is aluminium at 65mt, ranking third is copper at 24mt ahead of zinc (13mt), gold (3.8mt), nickel (2.4mt) and lithium (0.4mt). Even with the advent of electric vehicles that will expand the nickel and lithium markets, copper will be a beneficiary and maintain its rank.

The world produces around 100 million vehicles per year. A conventional vehicle has around 15kgs of Cu, and a conventional bus 90kgs. Their EV equivalents require 4x the copper. The 12% of the market that goes to automobiles currently will grow to be the largest consumption market. Other tailwinds will be the build out of infrastructure as the world electrifies to feed all those new vehicles. Consumer demand for the performance of an EV, and manufacturers demands for higher profit margins from the simpler to create EV machine are on track to see conversion rates from combustion engines to electric climb significantly. Volkswagen, Geely (includes Volvo) and Ford are already betting big on electrification, others are following.

Australia like with other resources sits nicely in the copper market. We are the world’s 7th largest producer, and from our blessed geology we hold the 3rd highest resource allocation. The largest miners of copper in the world are Chile and Peru. These countries find the Andes mountains within their borders and are home to porphyry copper deposits. This type of deposit come in lower concentrations of copper, but they are giants. Mine life of a porphyry mine can last more than half a century and this type of deposit is responsible for nearly 60% of the world’s copper production. There are two large active porphyry mines in Australia, located at Cadia Valley and Northparkes, NSW. Further potential is anticipated in the Victorian Lachlan Fold Belt and active drilling is taking place in the area.

Let us go a little deeper on how copper is formed and found. First copper is found throughout the Earth’s crust in a concentration of 33g of copper per tonne of rock. Mines become economic when they find concentrations of copper closer to 5kg per tonne (5% by mass), and ideally for a new mine the figure would be closer to 20kg per tonne (2% by mass). Subduction zones, where one tectonic plate moves beneath another, spurring volcanic activity are a perfect setting to melt and concentrate copper deposits. Porphyry deposits are formed adjacent to these volcanic areas through out geological time lying in wait for a curious geologist to discover their riches.

Copper has the property that it can be easily mixed with other metals to create alloys such as bronze (copper mixed with tin) or brass (copper and zinc). This property means that copper typically combines with other materials to be naturally found in ores that contain other metals of value such as gold, lead, zinc, and silver. Australia has significant resources in Mt. Isa in a copper-lead-zinc deposit, as well at Olympic Dam in South Australia that boasts a copper-uranium-gold play. The two ways to get the ore to market are underground mining, where you are looking for a seam of 2 metres in thickness or more, then you sink a vertical shaft with horizontal offshoots into the resource. The other method is open pit, where you remove the overburden rock above the resource and quarry the rest. Open pit mining is generally cheaper than underground mining but seen as far more invasive to the landscape.

Processing Copper:

We mentioned earlier that the ore targeted is between 0.5% and 2% concentrations in the ground. For sale, copper must be processed into copper concentrate (25% copper) or further into a refined product (99.99% pure Cu). To upgrade the concentration a multistep process is undertaken.

• Crushing and grinding: Giant ball mills take the unprocessed ore by the truck load and crush it into a fine powder.


• Froth and flotation: The now powdered ore is mixed with a paraffin oil that makes the copper in minerals water repellent. The paraffin coated ore moves to the bath with a foaming agent in it, jets of air create bubbles in the bath, and the coated copper floats to the top of the solution creating a froth. Unwanted rock left over from the crushing falls to the bottom and is removed. The froth with the copper is removed, the excess foaming agent and paraffin is recycled. After this stage we have 25% copper, and the mixture is called copper concentrate. Copper concentrate can be shipped to other plants for processing, it is quick to make and there are strong markets in China, Germany, and Japan for the material, representing a quarter of the entire copper market.


• Roasting: Copper concentrate is heated to over 500 degrees Celsius, cooking off sulphur, creating sulphur dioxide, which is recaptured and turned into sulphuric acid.


• Smelting: Now that we have a higher concentration of copper, we heat the mixture to 1200 degrees Celsius with silica and limestone. Further impurities are removed by the process and form a slag that floats on the surface is removed. Further sulphur dioxide is released and recaptured from the flue of the plant to be made into sulphuric acid.


• Copper Blister: The molten copper solution from the smelting process is called copper matte, and it is combined with air in a converter to create blister copper and more sulphur dioxide. Blister copper is 99% pure and poured into an anode mould that has two handles for easy lifting.


• Electrolytic refining: Finally, the blister copper is layered horizontally with many sheets and a high current is applied. The 99% pure copper transfers from the anode to the cathode in the newly electrified sheet, and the new copper that coats the cathode is 99.99% pure, ready for sale. Impurities like gold, silver and platinum are saved from the electrolysis process, whereas less valuable materials like nickel are discarded.


• From roasting to the final electrolytic step can take up to 3months, quite the lag in cashflow compared to selling copper concentrate.

Since copper is so intertwined with our everyday life, its price is considered a leading indicator of economic activity. If copper prices are climbing, the world’s economy is following suit and vice versa. For example, with China’s dominance of the copper market a fall in copper prices began to show the effects of Covid on the Chinese economy in early 2020. Prices of the red metal fell below $6000 USD per tonne in January 2020. A further sell off occurred in mid-February and continued to a low on Mar 23rd, 2020 when the market turned significantly. We now sit at all time highs for copper, with room to run. Many investment banks have noticed the structural supply shortage for copper and the increasing demand story from electrification.

The ASX due to Australia’s prolific mining background is home to many mining companies with exposure to copper and we regularly hold positions in our portfolios.

Updating our checklist:

• Valuation: The ASX200 P/Efwd is 19.44x and the S&P P/Efwd is 22.59x. Ratio levels are still elevated. We have seen earnings upgrades by analysts less earnings downgrades rise, which is typically a leading indicator for the market. Increased earnings momentum can carry a market.
  
  


• Global PMIs: In China figures continue to be strong as revenue growth was shown in all sectors outside of retail. New orders for export and domestic continue to show a rising trend for manufacturing. On the credit side, we see bond issuance following a downward trend, with figures now back to 2018 levels. Travelling to the US service PMI data is strong and the University of Michigan’s economic conditions index is on an upward trajectory from the low in March 2020, showing the American consumer is coming back. With that said figures are far from the 121 peak in Mar 2018 as we currently sit at 90, so there is ground to be made up, but the trend is positive.


• Downgrades on guidance: We are in between earnings seasons now, but we have already seen some confessions on the ASX ahead of year end. Costa Group has seen cooler temps, and I am sure you have noticed the signs at Woolies mentioning tomato, strawberries, blueberries, and raspberry supply constraints. La Nina brings cooler damper weather to Australia, and this has hurt yields for the farming group. CGC:ASX sold off heavily with the announcement of lower expectations. On the other hand, bank profits are turning up and bad debt expectations have fallen. Provisions taken in anticipation of loan defaults will start appearing as writebacks to the bottom-line boosting earnings. This trend has been seen across the pacific in North America as well as at home here in Australia.


• Infection rates to slow globally: Well Melbourne is locked down again, as the Indian variant of the coronavirus has escaped from the quarantine hotels in the area. Officials were quick to act and case numbers are still relatively low. The one-week lockdown should once again push back any infection explosion in the area. In Queensland, the vaccination program is well under way, and members of our team were even able to receive their first doses last week. The Victorian government is pushing vaccination quite hard as a preventative against future outbreaks and lockdowns, the number of visits to the registration site for vaccinations ended up taking the system down in the process. Australia’s vaccination rate continues to climb as more supply is being made available to the country. You can follow Australia’s vaccination journey with our live vaccine tracker at the link below:
  
  TFM Vaccine Tracker


• Monetary and Fiscal stimulus announcements globally: The RBA put out an interesting paper this week that looked in depth at the readability and reasoning of their announcements. The result was they need to be more effective in their writing so that economists and non-economists can understand reliably what they are trying to say. Now why is this important, well it is understood that the RBA wants its messaging to be a signpost of what their intentions are, no tricks, no innuendo. If they say no interest rate hikes for 2-3yrs they mean it. If they say no end to quantitative easing (QE) for 6months, that is their intention. The feeling is that if the RBA does end QE it will be after the US, Europe and Japan to avoid our Aussie dollar from going to the moon. In the United States the latest central bank minutes show that the Federal Reserve is thinking about beginning to talk about when QE in that country would be curbed. The June meeting in the next few weeks will be important on this front as the signal could be given and markets will react.
  

Another two weeks have passed, and economic indicators continue to improve. The central bank and government in Australia continue to be supportive to continue the recovery. We highlight again that the stock market does not always reflect the real economy as markets tend to be ahead on timing. When quantitative easing ends across the world, markets tend to sell off. We are currently holding more cash in our portfolios, or assets that are not in the direct firing line when the money from central bankers stops flowing. At this point in the cycle, it is a perfect time to seek advice from one of our advisors. They are trained to help you meet your financial goals and use our products to meet your long-term needs. If you do not feel like going it alone or find yourself with some extra capital, we recommend you get in touch with one of our advisors to discuss putting that capital to work. Take care and we will be in touch again in two weeks.

Regards,