Gianni Kovacevic: Pro-Copper Crowd Grows
Source: The Gold Report 09/15/2009
Corporate development strategist and consultant Gianni Kovacevic, back with The Gold Report for the second time this year, still takes a shine to copper—but he has a lot more company now than he did in April. As copper climbs, the Monday morning quarterbacks are changing their tune. Also a fan of molybdenum, which is often a significant byproduct of copper mining, Gianni says it does more than fortify steel for pipelines, vehicles and beams. He calls it the "glue" of any growing economy.
The Gold Report: When we spoke with you last April, you were very pro-copper, when many people were bashing copper. Some of them have turned around since. What's happening in the copper market and why so much enthusiasm now?
Gianni Kovacevic: How times have changed. Over this past year, as we saw copper tumble off, I've come to believe that we have a new rule book with different rules, and the rules are still being written. We're trying to understand how the world turns in this time, but my suggestion always was pricing for copper and most hard commodities will be stronger-for-longer due to man's ascent and overwhelming global growth, with the world's 6.6 billion (and counting) citizens. Many of these people have yet to begin to participate in basic progress.
TGR: You're talking primarily about people in the BRIC (Brazil, Russia, India, and China) countries?
GK: Citizens around the world; but yes, in the BRIC countries in particular. China, for instance, does not have enough domestic supply of critical commodities such as copper, steel and oil to sustain growth. They need better than six million tons copper a year from the overall global demand of 18 million tons. So basic math, in the next seven or eight years, they need 50 million tons of copper. At today's price—$6,200 a ton—that means they're going to deploy over $300 billion to meet this demand.
Do they care about 20,000 or 30,000 extra tons in a warehouse? No. Do they care about $2 or $3 copper? I believe they're more than happy to pay that all day long. All the while, they'll say they think the price of copper is too high and maybe they'll sell some—and then all of a sudden the price of copper goes up yet again.
Fortify all of that with what has always been there—a certain degree of investment speculation compounded by major global entities using commodities as dollar hedges that will not go away next week, month or year—and you have the makings of stronger-for-longer copper prices.
TGR: What if the China bubble bursts?
GK: I believe this is not a bubble. This is 1.3 billion people and the government basically being forced to provide infrastructure and backbone so outlying communities can have the same living standard as more developed parts of China.
TGR: How much more copper stockpiling do you expect in China?
GK: Having an extra 50,000 or 100,000 tons of copper when you're going to require so much of it is not what I'd call stockpiling; it is smart inventory level maintenance. Let's look at molybdenum, a sidebar to copper and the most common byproduct of copper mining. China has always been self-sufficient with molybdenum production. But in the first four months of this year, for the first time, they imported 10,000 tons of molybdenum. Do you stockpile molybdenum? Maybe. But the increased volume of finished steel they're creating does not just sit there. One does not mill, roll or finish steel unless it has a real purpose and is being used in projects somewhere. So this molybdenum that's being imported, I would suggest, is being used to fortify finished steel because we know finished steel is going up in China.
TGR: So you don't suppose they're stockpiling molybdenum either?
GK: I doubt it. When moly was trading on the currently not-so-transparent market at $10, $11, $12, it was arbitraged in China at $17 to $20. That suggested that moly had to go to $17 to $20. One more comment about moly. The London Metal Exchange announced that in February of 2010 both cobalt and molybdenum are going to be on a futures market, which will give a little more transparency and a truer week-to-week price for both. I would say that's a buoy and that's a solid fundamental for future molybdenum prices.
TGR: Copper is often considered the precursor to economic expansion and growth. You can't have it without copper. Moly is used to strengthen steel, which is arguably also fundamental to growth. So would you view moly in that same category as copper?
GK: Copper has a PhD on the economy, but molybdenum is the glue of any growing economy.
TGR: If part of the reason for playing the copper market is stronger-for-longer growth, and moly is the glue, will moly prices follow along with copper?
GK: Moly is a very interesting commodity. We use very small amounts to strengthen and fortify steel and for its anti-corrosive properties. It's what we use to remove sulphur from diesel fuel. Look at a petroleum pipeline, for example. The pipelines they built 40 years ago are now failing and corroding because they did not have enough molybdenum content. Many jurisdictions in the world now require as high as 1% moly content.
What does that do for the price of moly? Well, in a petroleum pipeline, for each kilometer in length, you need approximately 1,000 pounds of moly. The world is going to build in excess of 100,000 kilometers or more of pipeline in the next six to seven years. Like copper, moly has grown 4% year-over-year for about four generations, one heck of a long-term reliable trend. So from a price perspective, if moly's $10 a pound, it's going to cost $10,000 in moly for each kilometer of pipeline. If the price goes to $30, it's going to cost $30,000. Does a $20,000 increase really matter on a project that costs millions per kilometer? Of course not. Whether you fortify steel for automobiles or beams or pipelines, the amounts needed are so insignificant that even if moly costs $30 or $40 a pound, it doesn't change the economics of the finished product in many cases.
TGR: The China story hasn't really changed since April, but as we discussed at the start, the analysts' views on copper have. What's behind that?
GK: Let's use Quadra Mining Ltd. (TSX:QUA) as an example of the situation we had six months ago. Quadra is one of the premiere mid-tier producers of copper one can invest in by way of its public listing. It's located in politically stable jurisdictions—in fact, the best copper mining jurisdictions in the world, that being Nevada, Arizona and Chile. Back then on the high side we had Tom Meyer of Raymond James with a $21 target (current $19) a share for Quadra. At the same time, UBS had a target of less than $3 per share. Someone had to end up massively and shamefully wrong. Quadra is trading at almost $13 now, and within the past month, UBS has significantly increased their short- and long-term forecasts for copper to a degree never seen before.
But six to nine months ago, that was the mentality. Those who knew copper the best loved it the least, because they'd been hurt the most. Reading the pages from the old rule books at that time, they saw a world with no demand, where people weren't going to buy anything, and where there was no possible way that copper and hard commodities would increase in value under those circumstances. But sure enough, here we are. Copper's testing $3 per pound and the Monday morning quarterbacks are changing their tune. This is not to be taken as an insult because we value all opinions even though we were copper bulls, but when one is convinced of a certain view then they should study the other side of the argument to see what they might be missing.
September to March was not a time to guess what the market would pay for anything, which is why I was saying, "not until we have economic and physiological neutrality will investors know what the market will pay for a pound of copper, an automobile or bowling ball, for that matter." Those that cannot live without copper led the charge this past spring/summer and now it is testing $3 as we approach some sense of normality as many countries, technically speaking, are out of recession.
TGR: Can you give us an update on Quadra?
GK: Quadra has three producing mines—in Nevada, Arizona, and the soon-to-be-completed Franke project in Chile. They own all their projects 100%. So you've got a company with very well-anchored, well-managed copper production, but in the next four to six years, they could become one of the world's largest producers of molybdenum.
They've released a scoping study on their world-class number four development asset, the Sierra Gorda project, located in the Atacama Desert, Region II, in Chile. This is a company-making asset that could produce 33 million pounds of molybdenum for the first eight years and between 250 and 400 million pounds of copper. That would complement the current production profile of about 250 million pounds of copper production for 2009 (280 million pounds in 2010). Voila, Quadra goes from established mid-tier status to what one of the larger global players, and this would be achieved organically. Quadra's number five asset, the world-class Malmbjerg project in Greenland, would also produce about 25 million additional pounds of moly per year. Both Sierra Gorda and Malmbjerg projects are well situated and very financeable, and I think Quadra's management team can fulfill strategies to perhaps have partnerships. Very few major companies wouldn't want to be a partner, particularly in Sierra Gorda.
Either way, Quadra will certainly participate in the enormous value that's to be unlocked there. This is a fantastic asset in the best copper mining district on the planet with one of the most prudent management teams in the entire space and shareholders don't really pay for it as the current production assets are still undervalued, in our opinion.
TGR: As an investor, how do you price a company such as Quadra, which has significant moly production as well as copper production? Because they're pretty much in the ground together, do moly prices tend to go up and down together?
GK: Just to clarify, Quadra is not a molybdenum producer yet. This is a development project. Nevertheless, one way I look at a company is in terms of replacement capex. Quadra currently has three operations with replacement capex of about $1.5 billion. With 100 million shares out, that's about $15 a share just in replacement capex. Being very cautious in these economic times, you can get a base minimum value of the replacement capex. And then let's not forget it's a business—a cash flow positive business—so attribute something of that to the value. Trading around $12 per share, Quadra is pretty well anchored to the downside, yet has tremendous leverage to future copper prices as many businesses go beyond "break-up" value and have some value attributed to their core business.
Can you believe in this incredible rally there are still situations trading at well below break-up value? That is how ridiculously undervalued some companies became in the greatest investing opportunity in the past 100 years. That was how we saw October 2008 to the summer of 2009.
TGR: Is Mercator Minerals Ltd. (TSX:ML) another copper-moly play?
GK: Depending on the price of those two commodities, you can call it a copper operation or a moly operation. Their project in Arizona, which I've visited, was designed as a molybdenum project with significant copper by-product credit, a perfect formula for our investment philosophy. Per guidance, they should produce around 5 million pounds of molybdenum this year, and that will grow to about 10.5 million pounds when they wrap up phase two next year. The company recently announced a $70 million bought deal financing that's going to take place at $2.50 a share.
In a grossly undervalued situation similar to Quadra's, Mercator had an operation worth approximately $500 million in replacement capex and a market cap that was 5% of that when it traded at 0.30 9 months ago. That suggested "undervalued" and pointed toward a very nice cash flow positive business if metals prices returned, and sure enough it is up around 1,000% yet still below replacement cap-ex and they are cash flow positive.
TGR: Would a company that produces both moly and copper be inherently more valuable because the moly has an inelastic price point while copper fluctuates?
GK: I like anything with a significant moly byproduct. That's a good thing. Call moly an insurance policy on copper, or one of the other commodities. Mercator will produce better than 50 million pounds of copper and just over 10 million pounds of moly next year. That's a pretty good insurance policy.
TGR: Another company you mentioned last time we interviewed you was Copper Mountain Mining Corporation (TSX:CUM).
GK: Being from British Columbia, I know Copper Mountain very well. It's a past producer with a very strong development team. Career mine builder Jim O'Rourke is leading the charge there. Mitsubishi Materials Corporation (Pink OTC Markets Inc.:MIMTF) decided to earn in to that project, which should be producing within the next 24 months. One of the big metals companies of the world, Mitsubishi's decision provided major validation for the asset. They opted to earn 25% by giving Copper Mountain $28.75 million, which implies a valuation of about $115 million to for the project.
When Mitsubishi does a deal like this, we don't see them walking away after all that due diligence in otherwise strong projects. They did, in fact earn in at the end of July. They also will provide about $250 million in debt financing.
Copper Mountain does have to come up with a little bit more equity, thus they are raising $50 million at this time but we just were looking at it as one of only a very few near-term development projects. We saw an opportunity when it was trading around 0.50 cents, having a $15 million market cap, and owning 75% of the project. It was pretty much a slam dunk for us and, sure enough, it's about $1.30 now.
TGR: Considering it has 18 more months before production, will Copper Mountain trade in that neighborhood for the next year or so? Or do you see it rising sooner?
GK: I can't forecast where the price will go, but I look at a market cap of $45 million and the fact that they still own 75% of the project. Mitsubishi paid $28.75 million for 25% of the project. That's pretty good math. I think Mitsubishi knows what they're doing, so Mitsubishi earning in at that level implies conservative upside value just on the basis of that math, let alone what that business would be going forward. And I like Copper Mountain going forward.
TGR: Not long ago, Peter Campbell of Jennings Capital told us that copper won't go back to $1 a pound—the floor going forward will be at least $2. What's your feeling about that? And how high do you think it might go?
GK: What will 12 thirsty people pay for 11 cans of soda? I don't know, but I do feel pretty good about that fight as consumers and merchants around the world scramble to obtain more and more supply that has not been and will not be brought on-line due to lack of financing and a dearth of new discovery. Maybe looking at history will help. In 1980, 30 years ago, copper was $1 a pound. A Big Mac was just under a buck back then. Today you pay $3.50 to $4 for a Big Mac. We had a situation where the price of copper stayed at or below one dollar a pound for 25 years. In a perfect world, copper should be around $3.50 to $4.50 a pound, just on the basis that anything else at the time that was around a buck is now in that range. But commodities are not inflation-adjusted perfect and we all know that they fluctuate. And don't forget, we have fewer big producers than 10, 15, 20 years ago.
It costs between $1 and $1.50 to get copper out of the ground, so at $1, and maybe even at $2 per pound, the now fewer existing big producers of the world would turn down production on a dime, as they just have this past Q3 and Q4 of 2008, to balance against demand destruction.
The copper price also will depend on what the U.S. dollar is worth and what the global economy is doing. We've never had a time where the U.S. dollar has been so unanimously unpopular. People who have a lot of U.S. dollars are going to perhaps hold commodities (such as copper, which they need anyway) as monetary instruments to hedge themselves, which would tend to push the price and or hold it yet higher.
DISCLOSURE: Gianni Kovacevic
I personally and/or my family own the following companies mentioned in this interview: QUA, ML and CUM.
Gianni Kovacevic, who works in corporate development at Global Opportunities AG Zurich, Switzerland & Kovacevic Consulting, brings more than a decade of investment experience in the resource sector to the task. In addition, over the past several years he has assisted with negotiated financings well in excess of $250 million from a large pool of global investors. A widely traveled citizen of the world who cultivates and nurtures relationships everywhere his interests take him, Gianni is fluent in German, Italian, Croatian and English, and is busily mastering Russian as well. A tireless researcher and avid reader, he maintains homes in both Vancouver and Zurich.
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