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TALK TO AN EXPERT: Bart Melek Makes The Case For Base Metals

In our latest conversation with BMO Senior Commodities Analyst Bart Melek, we discussed the direction of commodities and markets for 2010. Mr. Melek is no pessimist this year. He sees plenty of opportunity for upside remaining, particularly in copper, iron ore, platinum and zinc. On the other hand, he worries that sovereign debt in some European countries could derail the recovery to date. Should that happen, he says, gold will be a popular investment choice.

Resource Intelligence: Your division of BMO researches and writes reports throughout the year on all sorts of commodities, from coal to copper. You must notice a lot of trends. So from an economic and investing point of view, what sort of trends defined 2009?
Bart Melek: Well, 2009 was initially characterized by a very dismal macroeconomic environment. We saw the worst growth since the 1930s, which then precipitated an extremely sharp correction in commodity prices, ranging from base metals, to oil, to iron ore. During this cycle we’ve actually seen a 60% decline in as little as 10 months and normally those declines don’t happen that quickly and certainly not that sharply, but the macro environment was quite poor at that time. 
After the government of China and the government of the US and central banks around the world started adding massive amounts of money in a co-ordinated effort globally, about $2.2 trillion in aggregate and lowered interest rates to record levels, we started to slowly see an increase in the latter part of the year. Certainly the optimism about commodity markets and the future of commodities rebounding helped a great deal. 
In fact, if you take zero to be the start of the recession, after a 60% fall we recovered back to the -20% mark, so we recovered much of what was lost in a very, very quick time and we’ve not seen anything like that before. The take away from this is the following: Demand in China was pretty decent because of the massive stimulus they implemented there, equal to about 14% of their economy in terms of direct physical spending and infrastructure and such. The implication there is that the supply lines weren’t particularly overdone, in essence. For many commodities, like copper for example and commodities like zinc to some extent, the supply or inventory relative to demand weren’t all that high by historical standards. Keep in mind that this was the worst time in the demand environment, certainly in my lifetime. So all in all it wasn’t too bad and to some extent, for those reasons, this is why we have seen such a sharp recovery.
RI: If we have come out of this relatively unscathed, what do you think will define the coming year?
BM: Well, you know, I would say this year is not going to be a year where we see these sharp accelerations anymore. I think we will see some upside later in the year as per this correction that is unfolding currently. Again the key reason here is, we are going to see restocking globally. We are going to see significantly better growth in the developing world and I think China will continue to do fairly well down the road.
RI: What commodities then are you focused on? 
BM: We have an order in the criteria from which we pick commodities. First of all, in order to be top ranked as far as we are concerned, demand prospects have to be decent in the short run and long run and supply shouldn’t be expanding at a greater pace than demand. The other criteria  that I use is China shouldn’t have any, which means they can’t distort the market, produce below cost and subsidize. And what fits that cagegory? Copper for example. Demand looks good because of infrastructure, building and industrialization within China. I think over time, India and the current build up of power supply,  build up of transmission lines, roads, infrastructure of all sorts, from logistics to telecom, copper is going to be used. Demand looks robust there. 
There is a mass migration from the rural to the urban settings in countries like China. I think that is going to start increasingly accelerating in India and other parts of the developing world. That, by definition, means massive building of infrastructure and capital spending. Since 2000, we’ve seen some 150 million people in China move to the urban centre. You add India to that and who knows, ten years down the road, in the next decade you might have 300 million people moving in to cities, and that is equivalent to one United States of America being built up. So there are potentially massive upsides to demand for commodities and something like copper, with not too many mining projects out there, and something like zinc, not too many projects out there long term, so there is a very good chance of a very tight market down the road. Iron ore is another one, what is it used for? Steel, which is the commodity for infrastructure and development—when you are thinking of building out roads and factories, you have to think steel. 
RI:  Ok that’s iron, copper, and you mentioned zinc a little bit
BM: Platinum is another one which we think, certainly for the immediate future. Certainly not in the recent corrections, not withstanding. Again, we had a massive decline in demand last year.We see some of that coming back. Inventories are lean, supply side is tight, certainly in South Africa, so there could be some significant upside pressure as this recovery takes hold.
RI: Copper has in the past made repeated stabs at $4.00/lb. Now that global growth is back on track, to some degree, could we see that again?
BM: Look, we are actually forecasting a copper supply deficit in 2011. That means a potential price increases, and as the year unfolds the prospects of an environment where the economy does well given the supply chain of mined copper and secondary supplies out there, we could very easily see it test historic highs.
RI:  And yet China is developing a huge copper deposit in Afghanistan. It’s fairly early stages I believe, the Aynak deposit in Afghanistan, which has some 11 million tonnes of copper. Has China become more aggressive in acquiring metals projects, or is that just perception?
BM: Certainly I think the evidence is there with some of the iron ore deals and some of the deals in Latin America. Certainly with energy broadly they have become more aggressive. There is a very good reason why. They have well over $2 trillion in reserves, they are worried about the US dollar preserving its value and frankly they know they need the material to fuel their growth.
RI: So do we need to be more aggressive?
BM: I think aggression of this kind is only a prerequisite if you’re actually growing.  At this point, I don’t think we have been focused on that, but who knows, if prices and supply becomes an issue then that could very well develop.
RI: Let’s talk about peak metals. Everybody knows the peak oil argument, which states that we’ve reached the maximum possible production of oil based on existing reserves. Do you think the concept of peak metals is nonsense, or is there real concern?
BM: Well, I’m not much for buying into the idea of peak oil or peak metals. There is plenty of oil out there. The question is, at what price? There are plenty of copper resources out there. Africa—the African continent in particular— has very high-grade supplies of copper. Unfortunately there is a lot of geo-political risk there and its infrastructure is an issue but, again it’s a matter of price. There exists a price at which a lot of things get developed. Low-grade, high tonnage operations that weren’t viable previously, become viable at different price points. So I wouldn’t say there is a peak, at least not for the foreseeable future. The question is, at what price? Certain resources are not considered a resource because they are not economic, but at a certain price they become a real resource. You can turn a gravel pit into a real mine if the price is right. If the economics are there we don’t really have a shortage. What we have is a shortage of cheap, easily accessible material in geopolitically stable parts of the world.
RI: So what role do junior explorers play in that?
BM: I think junior explorers have a great function to play in the sector ultimately and I think a great many majors rely on them to be their sniffer dog, so to speak. With a positive demand environment and a high price environment in particular, I think the juniors will do well, because you will need them to find the next economic mineral deposits. 
RI: Ok, let’s talk about Nickel. Nickel also has been through incredible highs and very profitable periods. Back in 2007, the price of nickel rocketed such that a single drill hole from a junior could set their stock on fire. Will we get back to this kind of growth? 
BM: Certainly not for a while. We have an awful lot of Nickel out there and there have been large mine supply cuts in Nickel, so really I don’t expect a lot of upside for a while. It has large inventories right now and demand has not really started turning. We had considerable mine shut downs in 2009 because of low price environment and much of that stuff will start coming back, so I think the supply side is much better. For the very long term, I think that most metals have supply issues, but in the next few years that is probably not the case for nickel.
RI: It seems that in spite of the fears of liquidity in 2009, there was really no shortage of funds available for miners and some explorers as well, with good projects. For example Salman Partners raised $7.7 billion dollars, mostly for resource companies in 2009. Are they going to continue to see those kinds of funds being available in 2010?
BM: I don’t know if we are going to see those kinds of funds, but to reiterate, certainly earlier in 2009 and late 2008 we weren’t quite sure if we could do anything. So the environment has certainly changed with the recovery. I think that down the road, a good project will find capital. I think for the most part, if it’s economic and it’s the right project, I think investors will be more than happy to provide the funding.



Disclosure: No Positions