The Metals Report: Joachim, is the smart money finding its way into mining equities?
Joachim Berlenbach: At the moment, no. When we talk with investors, we hear a lot about risk relative to commodities and commodity equities. But I hope investment grows because the commodity cycle is far from over. There are two important benchmark numbers to consider. In 2012, for the first time, the world used more than 20 million tons (20 Mt) copper. Second, the world now needs more than 90 million barrels (90 MMbbl) oil each day. Every investor needs to remember these two numbers: 20 Mt and 90 MMbbl.
TMR: Are you more bullish on copper than gold at this point?
JB: I am fascinated by where the copper market is going. It's more interesting than gold right now. Also, if the copper market is tight, then we will really have problems as countries like China or India continue to develop. Copper is necessary to building a modern society. It goes into all kinds of infrastructure and is needed in cars, electrical appliances and houses. And there are very few substitutes for it.
We are at a critical point, because it takes at least 10 years to develop a big copper mine from the first bore hole to production. Anglo American Plc (AAUK:NASDAQ), BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and some smaller companies are curtailing their expenditures and cutting their exposure on building new mines. We will not be able to build that if investors remain so risk averse.
As for gold, I think that it ultimately must be monetized. I believe that gold is the best currency we have, but we need to see more proof that gold really is money. Too much of the focus on the gold sector is on U.S. interest rates and not enough on remonetization. We need to be more aware of deals like Iran selling its oil to Turkey or China for gold. Do you believe China has 1,054 tons gold in reserve? I do not. China is both the biggest producer and importer of gold. News from China on the gold side could be very bullish for gold and could be an indication that gold is becoming more monetized.
TMR: Do you see global consumption of copper exceeding 20 Mt in 2013 or staying static?
JB: I think it will increase. There is a very good correlation between a country's gross domestic product (GDP) growth and its copper demand. China's per-capita GDP is around $8,000, and it uses around 6–7 kilograms (6–7kg) copper per capita, up from 4 kg in 2009. That may not sound like much until you multiply that 2 kg difference by 1.3 billion (1.3B) people.
Assuming China's GDP grows by 7% per year, by 2021 its per-capita GDP will be around $15,000, about the point that marks the establishment of a healthy middle class. You can also calculate that China will need around 13 Mt copper in just eight years. That increase in demand equates to roughly 1 Mt per year. To meet that need, we must explore and build mines. And the mines will have to be bigger, because copper grades are coming down rapidly. Falling grades is one of the biggest sources of cost inflation in the copper industry.
Another fascinating element is development in the alternative energy sector. Some of the biggest wind parks in the world are being built in China, and both Germany and the U.S. are building their wind power capacity. To build a wind turbine that produces 1 megawatt of energy, you need approximately 4–9 tons of copper for use in both the turbine and the cabling that connects a turbine to a transformer.
I have been consulting with Siemens AG (SI:NYSE), the German electronics supplier. It is concerned about the copper supply, as well as supplies of certain rare earth elements (REEs) needed for magnets in wind turbines. Added together, current copper demand for wind turbines and alternative energies amounts to only a few hundred thousand tons per year (tpa), and the new projects coming on-line may cover that demand. But if the world really goes for all types of alternative energy, the current drive toward 25–27 Mt of copper demand in 2021 could accelerate to 30–35 Mt. We need a certain copper price to build the mines needed to meet this demand. If the copper price should go down to $1.30 per pound ($1.30/lb), as it did in 2008, there is no way that we can build these mines.
TMR: Do you see copper continuing to have price support above $3.50/lb in 2013 and 2014?
JB: Definitely. If we are lucky, we may add 1 Mt production this year, but the production costs are rising significantly. I am very happy with $3.50/lb, and expect to see $4/lb or more over the next few years. What we need to do—and this is in the domain of politicians and regulators—is take speculation out of critical commodities like copper and oil. Too often, hedge funds create volatility by selling or buying for short-term profit taking. A good example is the copper exchange-traded funds (ETFs) of JPMorgan and BlackRock. The companies claim that the copper they are using will not affect the price, but it will. We saw it happen with the sellout of the gold ETFs; 200 tons were sold and immediately the gold price went south. The same can happen with copper ETFs if speculators decide to sell. It will create volatility in the copper price that the industry cannot afford.
If the copper price bobbles back and forth between $1.30–4, the industry will not be willing or able to put money into new projects, exploration or mines. There is a real danger that, if we do not invest, we will not be able to build the mines we need. In turn, that could result in an explosion in the copper price, which we do not want.
TMR: Is copper the best way to play Chinese growth?
JB: I think so, copper and oil. Demand for oil in China is reaching 10 MMbbl. Gold is another longer-term play in China. Zinc also should be on investors' radar screens.
TMR: Some miners produce a concentrate and ship it to be smelted elsewhere. Others produce and refine copper cathode on site. Which approach do you prefer?
JB: We do not have a preference. It comes down to what the treatment and refining costs are that must be put through the company's discounted cash flow (DCF) analysis. The figure you end up with is the upside of a company's target price relative to the share price. If the equation comes out favorably, either copper cathode or copper concentrate will work for us. Most copper concentrate grades are in the 24-36% bracket. If your copper concentrate is 40% or 60% copper, it is worth quite a lot. Concentrate from the privately owned La Escondida mine is high-grade (up to 49 % copper) concentrate based on chalcocite and pyrite. Hana Mining Ltd. (HMG:TSX.V) reported a final copper concentrate grade of 52.5% from the metallurgical conventional flotation recovery testing of the chalcocite zone at its Ghanzi project. But again, we focus on the gap between DCF analysis-derived target price and the current share price and we consider the operational parameters in our analysis. A high-grade copper concentrate alone does not necessarily make an attractive investment.
TMR: Where do you like to see cash flow per share?
JB: We seldom look at cash-flow multiples. We look at net asset value (NAV), calculated under a given discount rate. What is important is which discount rate we need to apply, depending on the risk we are prepared to take. Then we look at NAV in relation to the current share price. That really presents the company's long-term value.
TMR: Can you give us a rule of thumb that works for you in terms of NAV versus share price?
JB: Today, we look at nothing below 30% upside over a year. Today, lots of companies have 50–80% upside of NAV relative to the current share price. We rigorously get out of the share when our target price has been reached.
Of course, the commodity price is also important. If we are more bullish on the commodity, our NAV will go up. We take very conservative but realistic commodity prices. For example, we are using a copper price of $3.603.70 in our models. The commodity prices we use in our models have gone up each year for the past six years, because break-even prices define the copper price that you use. I think it is important to stay conservative and not be too optimistic. The critical point is: At which commodity price will a company be able to produce a certain amount of a natural resource?
TMR: You mentioned zinc. Are you playing zinc, and if so, what is your investment thesis?
JB: We are not invested in zinc currently, although we are looking for a good zinc producer. In 2013 the zinc market may be less attractive than copper, so we are happier in the copper space right now.
TMR: Two large copper mines will enter production this year: the Ministro Hales owned by Corporación Nacional del Cobre (CODELC), the big Chilean national company, and Rio Tinto's Oyu Tolgoi copper-gold mine in Mongolia. How will the increased copper production from those mines affect the supply/demand balance?
JB: The capacity at Oyu Tolgoi is around 400–450,000 tons (400–450 Kt), which moves supply in the right direction. But the mine has been delayed and will be more costly than was initially anticipated. Ministro Hales is a bit smaller, probably around 150200 tpa, but still a big mine. It took more than eight years from the first bore hole until production and declaration of the reserves. This emphasizes the dire straits we face in coming years. These two mines together could produce perhaps 600–700 Kt per year. If we need to add 1 Mt copper every year to reach the 27–28 Mt copper the world will need over the next eight years, we still have a bottleneck.
You also need to look at the projects that are supposed to be producing lots of copper, but are declining. Barrick Gold Corp.'s (ABX:TSX; ABX:NYSE) Cerro Casale, a copper-gold deposit, has seen significant cost inflation projections. Production has been delayed and it's now uncertain when (or if) the mine will be built. Mine road construction was supposed to begin in Q4/11 and pre-stripping of Cerro Casale was supposed to begin in Q4/12, two years before to the initial start-up of the sulphide plant. Sagittarius Mines Inc.'s Tampakan project in the Philippines has 340 Kt, but its environmental plan has been rejected and permitting is uncertain.
TMR: How are you playing copper, Joachim?
JB: We are looking at mid-cap producers. We like Nevada Copper Corp. (NCU:TSX), a high-grade copper deposit in Nevada. It looks very positive in terms of licensing and community support. We visited the deposit 18 months ago and were encouraged to see how quickly the company was able to get into that mine. It has great exploration upside and the costs should not be too demanding.
We also like Capstone Mining Corp. (CS:TSX), a producer with free cash flow and excellent exploration upside in Mexico and Canada. Its Minto deposit has gold, making it a gold-copper producer—two of the metals we like in one producer. Capstone also has the Cozamin project, and is building another mine that should come on-line over the next few years, although it has some financing issues. The new mine and Capstone's exploration upside could provide quite a bit of growth.
TMR: Are there any other stories you would like to share with us?
JB: In the Democratic Republic of the Congo (DRC), we looked at Mawson West Ltd. (MWE:TSX). It has two really high-grade deposits; the Dikulushi project is already mining and Kapulo is an excellent exploration project. The grades are high, but being in the DRC is an issue. There are some rumors now regarding increased taxes and royalties. Management is very open about these potential regulatory changes. Risk-tolerant investors might prefer limited exposure.
TMR: Is Mawson West a takeover target?
JB: It could be a takeover target, perhaps for a company like First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) in Zambia. If you could take Mawson West and put it into British Columbia, Ontario or somewhere in Canada, it would have been taken out long ago. But you have to tread carefully in the DRC and limit your exposure.
TMR: Do you have some parting thoughts for us?
JB: As with other commodities, the market should be prepared to take risks. Companies likewise need to be prepared to put risk capital into new projects. There is a discrepancy between the near-term reality of interest rates, dividend yields and capital gains and the longer-term need to secure the production of commodities. The natural resources sector is different than other industries; it gets tight if we do not invest and build mines. Regulators could also take some of the speculation volatility out of the market.
There are great copper companies out there, although investors need to do their homework. You need a detailed analysis of the geological setting and the financial statements. And of course, investors need to decide if they are prepared to go into jurisdictions that are a bit riskier than they may be used to. We always ask whether we, as individuals, would be happy to go to a given country. Would I go there on vacation? If the answer is yes, perhaps it is a jurisdiction that I also would be prepared to invest in.
Joachim Berlenbach is an advisor to the Earth Exploration Fund UI and the Earth Gold Fund UI, in addition to supporting the analyst team of the Earth Energy Fund UI. He is a structural geologist by training and worked for 11 years in the South African gold and platinum mining industry. Following his operational occupation in the mining industry, he worked for six years in investment banking where he was rated best South African gold analyst (2001 and 2002). Before launching the ERIG funds with Universal-Investment in 2006, he co-founded Craton Capital in 2003 and has since been in fund management and consulting. He has a substantial network of high-level contacts in the South African and international mining and investment industries. He is a guest lecturer in economic geology at the mining school in Freiberg and the University of Münster, Germany and a retained speaker on mining valuations in the international CFA program.
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