Improving U.S. And Chinese Economy To Support Copper Prices

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 |  Includes: FCX, JJC, SCCO
by: Alpha World

Summary

After a dismal Q1, copper prices bounced back in Q2.

A recovery in copper prices augurs well for the likes of Freeport-McMoRan and Southern Copper.

There have been worries over copper prices again recently, but there is strong support now due to improving U.S. and Chinese economies.

The key for miners will be to reduce cash costs.

Copper prices have made a reasonably strong comeback this year following a weak performance in the first quarter of the year. Indeed, copper prices nosedived 10% in the first quarter of the year, as sluggish economic data from the U.S. and China at the beginning of the year -- along with widespread concerns over China's trade financing deals -- shattered investors' confidence in the industrial metal. It looked like copper, which plunged 7.4% last year, was headed toward yet another dismal year as the fundamental imbalance that has marred the copper market in recent years appeared to widen, with global miners planning to ramp up production -- even with the backdrop of macroeconomic uncertainty.

Copper prices, however, bounced back in the second quarter. The red metal gained almost 6% in the second quarter as the U.S. economy started to gain momentum, and China's economy also showed signs of recovery thanks to Beijing's "mini-stimulus" package. Copper prices also benefited from a series of production disruptions this year, which reduced the glut accumulated over the years.

The inventory levels at warehouses monitored by the London Metal Exchange (LME) fell to just under 150,000 tons in the first week of August, the lowest level in almost six years. Copper prices, which took a pounding in March, rose more than 1.5% in July. This was the third successive monthly gain for copper.

Not surprisingly, the start of a possible up-cycle in the copper market augurs well for copper miners such as Freeport-McMoRan (NYSE:FCX) and Southern Copper (NYSE:SCCO).

Recent Worries

Recently, though, concerns have resurfaced over copper's outlook. In late July, the Indonesian government announced that it will be removing its ban on copper ore exports, in place since January 2014. In order to boost the nation's manufacturing prowess, the Indonesian government banned mineral ore exports so that mining companies could focus on vertical integration. Freeport's copper output in Indonesia fell by 45% due to the export ban.

The removal of export ban following rounds of backdoor talks between Freeport and the Indonesian authority is expected to boost global supplies, even as Newmont Mining (NYSE:NEM) is close to signing a memorandum of understanding with the country. And that would allow resumption of shipments. Freeport and Newmont account for 97% of the total copper production in Indonesia.

The announcement comes at a time when the world's leading consumer of copper, China, has huge stockpiles of metal. Last week, prices came under slight pressure as rising stockpiles of the metal monitored by the Shanghai Futures Exchange stoked fears of an impending glut. According to data from Shanghai Futures, deliverable inventories rose 37% in July to 108,393 tons, the biggest increase recorded since February 2012.

The development has fueled speculation that copper prices may once again feel the heat as the market's fundamental imbalance would continue to hurt the metal's recovery. While it is true that the copper market is likely to see a surplus as miners ramp up production, fears that copper prices could yet again come under pressure, just like earlier this year, are uncalled for. In fact, building some exposure to copper miners wouldn't be a bad idea at this point of time.

Indeed, the demand for copper has picked up recently, which would provide a floor now -- unlike at the beginning of the year when feeble macroeconomic environment weighed on prices.

Factors That Would Support Prices

To begin with, the turnaround in the U.S. economy from the second quarter onward augurs well for the red metal. According to the Bureau of Economic Analysis' preliminary reading, the world's largest economy grew at a stronger-than-expected rate of 4% during the second quarter after posting a decline of 2.1% year over year in the first quarter. The decline in the first quarter, however, was mainly due to extremely cold weather that had a negative impact on economic activities.

In China, the pace of manufacturing activities has gathered steam lately. In July, China's official purchasing manager's index (PMI) climbed to a better-than-expected reading of 51.7, after rising to 51 in June. The Chinese automobile market, the world's biggest, has been robust lately. Nissan Motor's earnings for the three-month period stretching from April to June received a tremendous boost due to solid sales in China. The Japanese automaker said that deliveries in China increased by 21% during that period. Likewise, U.S. automaker Ford (NYSE:F) said recently that it would increase spending to introduce its 23 latest models globally, as its sales in China rose 35% in the first half of the year. These developments should provide a floor to copper prices.

Not All Miners Are the Same

Even though a strengthening macroeconomic environment would provide support to prices, investors need to keep an eye on miners' costs. In order to lower its risks associated with volatile labor laws and less-dependable environmental regulations in international markets, Phoenix, Ariz.-based Freeport has been focusing more on its North American mines lately. In the second quarter of this fiscal year, the miner increased its production by 13% at its New Mexico and Arizona mines. That is a sound strategy given that there is a healthy margin between average price realized and the cash costs Freeport incurs at its North American mines.

Indeed, the average price realized during the quarter stood at $3.16 a pound, while the company's cash costs have remained consistently below $2 a pound. In the recent quarter, the miner lowered its costs per pound at its U.S. production facilities to $1.70 from $1.92. However, cash costs at its mines in Chile and Peru rose 6 cents a pound to $1.60.

By contrast, Southern Copper Corp. saw its net income fall 9.5% in the fiscal second quarter due to higher costs. For the latest quarter, cash costs rose by 2.2% year over year as the company met higher expenses associated with fuel, spare parts, and other materials.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.