Bullish on Canada and Iron Ore, Less So on Copper

by: Daniel Moser

Three noteworthy yet semi-unrelated items that stood out to me in the March 1st Financial Times were all somewhat relevant to commodity markets (see articles here, here and here - subscription required).

The Canadian Dollar: Neil Dennis wrote about the Canadian dollar hitting a three year high in the FT. As most people who have read some of my writing on SA will know, I have been a supporter of practically all things Canada for the past several months. According the article,

The Canadian dollar hit a 3 year high after strong growth in the 4th quarter prompted speculation that the central bank will soon restart its monetary tightening campaign.

While in theory the dire situation in the Middle East might spell trouble for the global economy, on a relative basis Canada should perform quite well. Their general exposure to a lot of things that other countries have to have.

Dennis notes two key points in favor of Canada:

  1. Annualized growth in the 4th quarter reached 3.3 percent after an upwardly revised 1.8 percent in the 3rd quarter which has been attributed to strong consumer spending and a 9.7 percent export surge.
  2. Recent purchasing manager surveys have indicated strong momentum in the first two months of 2011.

I would argue that a third point is the strategic oil position of Canada. They are flooding the United States with crude oil and ironically, thanks to Libya, they will be realizing quite an uplift in prices for their types of crude they export to the United States.

Couple that with countless stories practically every day about food shortages and food inflation...and one can paint quite a bullish story for Canada. So long as the Canadian central bank can keep their housing market within the realm of sustainability, they will remained positioned to prosper and their equity markets should perform quite well relative to other significant developed markets.

Moving on (not entirely unrelated to Canada)....

Equinox (OTC:EQXMF): The company made an offer for C$4.8 billion to buy Lundin Mining (OTCPK:LUNMF). In discussing this, the Financial Times reported that demand for the red metal is forecast to outstrip the supply, leaving copper mining companies in a scramble to add production. According the article, the combined companies (as described by Equinox) would be able to leverage each other's strengths and produce more as a combined company than either could produce on an individual basis. The FT quoted the Equinox arguing that the deal values Lundin Mining with underlying copper prices well below current market expectations.

The over-arching theme is that copper production is not particularly easy to come by as of late. This is fairly recurring in a lot of commodities. The analyst community, as I have written about in previous article, notoriously over-forecasts supply side growth. The simple fact is companies are looking to grow reserves. Faced with increasing challenges to get new mines up and going, they will look to strategic investments. It just so happens Canada is home to quite a few of these sort of companies.

It would be a disservice to anyone reading this to ignore the volatility/risks involved with commodity related markets/companies and that especially goes for copper. Since I last wrote about copper (see here and here), the market structure for copper has definitely turned more bearish. The market shifted from a slight backwardation (think strong demand for spot copper) to a slight contango for the first several (think better to store copper and wait out the weak period).

Seasonally, the first quarter or two are not very strong for copper demand; couple that with insane geopolitical (could turn macro in a heart beat) risks out of the Middle East and it is no wonder that the copper market (and copper related equities) have lost a bit of their luster. For those already involved with copper miners, adding additional exposure strikes me as a bit too risky (at least until the market structure moves to backwardation again).

For those looking for a little more exposure to emerging markets, commodities and inflationary assets, now might be just as good of time as any to pickup a little FCX or SCCO on a discount from high prices. Perhaps EQXMF.PK is worth a look over with a fine tooth comb, given its recent decline in price related to its bid for Lundin Mining.

Iron Ore: The last topic that caught my eye in the March 1 issue of the FT was related to iron ore. According to Amy Kazmin and Jack Farchy, India is set to raise iron ore export duties, which could potentially stand to push spot iron ore prices even higher (from already lofty levels). According to the article, budgetary concerns are linked with natural resource conservation which led this decision to nearly quadruple the export duty. The article noted that Indian iron ore exports were already declining and, in fact, the authors quoted Vale (NYSE:VALE) saying that

Last year's fall in exports was 'hardly a one off event' and was 'more likely a part of a trend, as India will need an increasing volume of iron ore to support its industrialization process and the badly needed large investments in infrastructure building.

The two authors noted that some analysts believe this represents an inflection point for the market as no one really knows what will happen to exports from India into China. Others believe this new duty level will make little difference as the marginal cost of production in India is far below spot prices in China as it is - although it will hurt Indian iron ore producers.

My take on this issue is that iron ore is setting up to be a market in a shortage or, at the very least , logistically constrained in the years to come - either way it typically means higher prices. Several emerging markets will be demanding more steel and that could mark an already tight iron ore market even tighter when you factor in that some of these rapidly growing countries are large iron ore exporters themselves and they will consider strategically decreasing exports.

My over all take:

  1. Canada looks terrific.
  2. Copper fundamentals remain bullish but market structure is weak and doesn't warrant taking additional risks at the current time if your portfolio already has commodity exposure.
  3. Iron ore is looking more and more attractive for a long term investment.

Good luck and thanks for reading.

Disclosure: I am long FCX, SCCO, VALE, EWC.