Key industry for decarbonisation

Commodities have fared better in the past. But since the beginning of 2022, it seems, the worm has been in the wind. Production, profits and revenues of mining companies are falling, only costs are rising. But the sector is consolidating and a bottom is in sight. Moreover, the current mine supply cannot meet demand for some metals. This applies first and foremost to the key metal of decarbonisation: copper.

By Stefan Breintner, Head of Research and Fund Manager of DJE - Gold & Ressourcen, and Manuel Zeuch, Commodity Sector Analyst

Commodity investments have not been among the favourites on the stock market so far this year. On the contrary: among the various sub-indices of the broad European market (Stoxx 600), the Stoxx 600 Basic Resources sub-index has even performed the worst with approx. -16%. After the abandonment of the zero-covid policy, the service sector in particular is currently recovering in China (the most important player in the commodities market). Commodity demand data from the infrastructure and real estate sectors are currently mixed at best and have also recently been below investors' expectations. Ultimately, the key to China's commodity demand recovery is likely to be an improving real estate market performance. Looking ahead to the coming months, the world's largest mining company BHP Billiton recently expressed optimism that the recovery will come. Home sales are already picking up in China's secondary market, and with time lag, new construction activity should also return. BHP believes that the positive effect of stimulus measures (including lower mortgage rates) will be increasingly felt in 2024.

At the beginning of 2022, the sector was overweight in most investor portfolios. This was especially true after the outbreak of the war between Russia and Ukraine, because sharply rising prices were expected due to sanctions imposed by Russia on the export of many metals and energy raw materials. However, it turned out that the market could only be influenced to a limited extent by the sanctions - they were less effective than hoped. Russia has hardly suffered any losses in the export of raw materials in terms of volume. Many (energy) raw materials now also find their way to the EU via third countries. Moreover, key metals necessary for the energy transition, such as copper, nickel or platinum/palladium, were not sanctioned at all. These two factors - a lack of supply shortages and a Chinese recovery that is taking longer than expected - were compounded by increasing fears of recession in the Western world. Together, these factors have led many investors to sell their positions in commodities and become underweight.

Cost inflation and operational problems of the companies

For some time now, production and cost figures as well as sales and profit figures have been disappointing for almost all listed metal and commodity producers. In the past, high-growth stocks such as Anglo American were no longer able to increase their volume output in 2022 and also had to accept a cost increase of usually more than 10%. The industry often talks about the fact that operational production interruptions have more than doubled in the past ten years. Experts do not expect an easing on the cost side for various reasons: On the one hand, the geology is getting worse, i.e. the ore or metal content is decreasing in the rock strata, making the ore more difficult to extract from the rock and the processing accordingly more costly. Secondly, the labour market for qualified personnel is tight, and finally, key resources such as water or electricity are often scarce. For these reasons, the costs of extractive industries are likely to remain elevated, even if those of oil price-dependent input factors generally fall. Such electricity problems or rationing are common in South Africa, for example, and water problems are a major issue in key producing countries such as Chile (home to about 25% of the world's copper and 40% of the world's lithium reserves).

A silver lining on the horizon

In the meantime, all industrial metal prices are cheaper than at the beginning of the year, mainly due to the uncertainty about the extent and timing of the recovery in China, the most important sales market. However, looking at analysts' estimates, which have already fallen sharply recently, it seems very realistic that we are now slowly finding a bottom here. The headwind for the sector from negative earnings revisions could therefore ease soon.

Copper is the key metal for decarbonisation

Besides the ongoing urbanisation, especially in emerging markets, the global efforts towards "decarbonisation" are the structural growth driver for many commodities or metals. Copper can be seen as the global key metal for the energy transition and, along with nickel, is one of the materials strongly needed for the transformation in the energy and transport sector. The demand prospects are promising: the annual installations of renewable energy generation capacities could more than quadruple by 2030, the number of electric vehicles sold per year could increase 18-fold by 2030 (compared to the starting year 2020). The expansion of renewable energy capacities goes hand in hand with a necessary expansion of electricity transport networks. The most important first use of refined copper is the so-called wire rod with approx. 74%: this in turn shows a market segmentation of approx. 63% power cables, 21% solenoid coils, 15% telecommunications cables and 3% special cables. Current forecasts by leading market research institutes (including CRU, Wood Mac Kenzie, International Copper Association, etc.) assume that by 2030, of an expected total demand of more than 30 million tonnes (2022: approx. 24 million tonnes), around 7 million tonnes will come from the energy transformation sectors (renewables, EVs, grid expansion). However, this additional demand cannot be met by more mine production, so that from today's perspective a market deficit of around 4 million t is assumed by 2030.

The copper supply is quite fragmented worldwide. The mine supply for copper is around 22 million tonnes. The remaining supply comes from the recycling of copper scrap, which will gain in importance in the future. A German company is considered the world leader in copper recycling. This company is also strongly expanding its recycling capacities, among other things through the construction of new plants in the USA, and thus has very good long-term prospects in this sector. New copper mining projects, on the other hand, cannot be launched so quickly: Large mining companies such as Anglo American or Glencore point out that the complete development of new mines (from discovery to production) today takes about 15 to 20 years. In general, the size of newly discovered deposits has been declining since the early 1990s. BHP Billiton forecasts that at least $250 billion will have to be invested for 10 million tonnes of additional capacity by 2030. Not much of this has been seen so far, which increases the likelihood of a prolonged market deficit, which in turn argues for high copper prices. Even in the short term, the copper price seems well supported on the downside after a 3% decline this year due to very low inventories on the London Metal Exchange (18-year low, moreover half of them of Russian origin and therefore problematic for many Western buyers).

Iron ore: similar shortage - further sector consolidation ahead?

A noticeable shortage is also expected for the seaborne market of high-quality iron ore in the next few years. Above all, higher-grade qualities (>Fe 65%) should be in strong demand, as these can be smelted with much less energy input and thus produce much less CO2 in the processing procedure. The CEO of the globally leading iron ore producer VALE from Brazil, Eduardo Bartolomeo, recently pointed out at the leading raw material conference of the Bank of America that most investors and market observers completely underestimate what is happening on the global iron ore markets. VALE believes that by 2030, available annual supply could be reduced by around 400 million tonnes, or more than 25% of total capacity. The reason for this is the progressive mining of ore in the most important mines with too little replacement investment.  In addition, production costs are increasing, especially at mines in Australia, as the wages of skilled miners are currently rising by about 25%. A popular means in the industry to replace reserves and pipelines at present are also acquisitions and mergers.

Mergers and synergies

In the field of large diversified corporations, the case of Glencore / Teck Resources is currently the most prominent example. Glencore is currently trying to take over Teck Resources in order to further expand its positioning in the copper (Glencore's CEO speaks of a gigantic "decarbonisation portfolio") and coal segments. Furthermore, the merger is expected to yield high synergies. While the outcome of this acquisition is not yet clear, there is little doubt that another major acquisition in the sector - but in the gold sector - will succeed. Newmont Mining wants to take over Australia's Newcrest and has already received support for this from the Newcrest board. This deal also seems to be driven by political interests, as Newcrest owns Waifi Golpu in Papua New Guinea, the largest undeveloped copper-gold deposit in the world, and this is now going into American (rather than Chinese) hands. In the past, Newmont has done a good job with the integration of large competitors (Goldcorp) and delivered more synergies than expected.

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