Show Transcript
While base metal prices like copper have been hitting all-time highs recently, volatility has also increased, leading to wild market fluctuations. Anthony Okolie speaks to Jacky He, Global Equity Analyst, TD Asset Management, about the importance of chasing cash flow yield not prices in the volatile copper market.
Print Transcript
Base metal prices like copper have been hitting all time highs thanks to tight inventories, regulatory changes and factory shutdowns impacting the supply side. But while prices have climbed higher, price volatility has also increased and could be here to stay. Joining me to talk more about this is Jacky He. He's a Global Equity Analyst at TD Asset Management. Jacky, we're seeing a lot of volatility in metal prices, particularly copper, which has pulled back pretty sharply over the past week from recent highs. Tell us what's happening here.
Hey, Anthony, thanks for having me. I think there's patent war between micro and nitrile. So when you think about copper, as you mentioned, it has a wide application in our daily lives, right? So in addition to copper's on supply and demand, there's also a macroeconomic outlook that can also play an important role to daily price moves. So what we saw recently, for example, earlier last week, we saw that the inventory at a new warehouse dropped down to the lowest level since 1974. Imagine what that means to short sellers who are obligated to deliver a copper or end users who depend on copper. They were at risk of having no copper, so they were forced to the market to buy at a much higher price. That's what drove the copper price surge. And then later on, we saw copper retreated pretty sharply as well. That was because the LME just put on some temporary measures to allow later delivery, for example. And also, the macro concerns about global growth came back again on the driver's seat that weighed down copper price.
OK, so despite this volatility, what are the fundamentals for copper and how tight is the market for this metal versus other base metals?
Yeah, I think that that's very important. When we think about fundamentals versus nitrile. When we look at nitrile, that's really about the story of demand, but a commodity overall is driven by a relative level between demand and supply. So when we look at copper, we are seeing supply has been lagging demand, that's creating a deficit and you are pretty much seeing a new metric joined almost everywhere. Look at the numbers we are seeing inventories sat about 20,000 tonne now at LME versus historical average about 260,000 tonne. So we are still at a record low. It was just overshadowed by a lot of macro headlines. You mentioned about other metals, I would say all base metals are pretty tight. If you look at nickel market, for example, it's seeing similar augmentary risks, right. And look at zinc, aluminum, they are all trading at a pretty elevated level and have been in deficit for quite a while. I do want to mention Anthony, I want a differ copper a little bit from the broader commodities because if you think about copper, it is not is not artificially type, that means it's not like thermal coal, where there's a central power that can influence the market a lot. And also copper, I would say, is the metal most exposed to the secular energy transition. So there are some sector tailwind here.
OK, so given that, what's your longer term thesis on copper?
Yeah. I think given that we are recognizing some near-term headwinds, but overall we are pretty constructive on copper over the long term. So when I hear of questions like, are we too late for a copper play, I would say no. And if I'm wrong, then we may be too early. The reason being that if you look at demand, we have just entered a period of accelerating decarbonization and such synchronized global effort is highly copper intensive. Think about a conventional car uses about 20 kilograms of copper versus EV year that uses about 80 kilogram. That's 4 times right there. And also, what we learned from recent global power shortage is we don't have enough renewables. If you look at from solar panels to wind turbines, they are also a multiple times copper intensive. Then the other side you look at supply. It's probably the more visible because mines are maturing, we are seeing consistently lower copper grades and we haven't put enough money nto a copper project, overlay that with increasing ESG. It's just making that supply start seem more visible down the road. The problem will worsen toward the end of this decade. The question is why we need to worry about this now is because copper protectors take many years to complete. So to narrow that deficit gap because imagery cannot connect it, right? So we need a higher price today to incentivize investment.
So I know that you're very constructive on copper for the longer term, but what are some of the near-term risks or headwinds for some of these base minerals?
Yeah, I think overall the risk is still centered around a macro economy. We talk about COVID. That has been a wild card for a while, but that seems like trending in the right direction. Well, hopefully we can see each other in person sometime, and then we see inflation that is squeezing companies' margins. If that stays much higher and longer than people thought that can dampen global growth. I do want to mention that historically copper itself has been good rightfully speaking against inflation and last, but not least, is China. People worry about slowing China, even collapsing China because of recent headlines about Evergrande, for example, and power shortage. I would just argue both of them are by design. Just because the economy GDP has exceeded the 6% target this year, so that leaves some lost room for regulation tightening. And also, don't forget, the policy makers do have a large toolbox to mitigate systemic risk. And I don't want to underestimate that particular ahead of the 20th National Party Congress later next year. Yeah.
And so for investors who might want to have some exposure to the copper markets, what's the best way to play this market?
Well, I'm not sure it's the best way, but what we are doing is looking at the fundamentals of companies. More specifically, we don't always trust what the company says, but we want them to show me the money, to extend as we want them to have superior ability to tolerate free cash flow. So the chart, I want to refer to this simply, aggregate the eight most liquid global pure copper plays from developed markets, and then we compare our free cash flow yield versus the broader market S&P 500 in this case. So what we see is the sporadic currently is at 5%. Well, what that means is for every dollar we invest in our copper company, we are getting compensated 5% more free cash flow versus the broader market. It's interesting from historical lens because we have been through three up cycles for copper over the past decade, but we were not getting compensated in the same way before. Current premium is just similar to early 2000, when copper really joined a supercycle. But to us it doesn't mean that we can close the eyes and just buy any copper company because year to date, certain names like Freeport can give you like 50% return. Another company can give you double digit loss, so we want to be highly selective here. Another thing we are trying to do is be active, be really active. Our friend Ben Gosic is our expert on our options strategy, for example. So while everyone was super bullish on copper, we were more cautious. But we didn't sit there and do nothing. Ben and the team has been writing put options on a weekly basis just to monetize that market sentiment, market volatility. So we were able to enhance the income at the same time collecting the copper company's shares we like at a lower price.
Jacky, thank you very much for your insights.
Thank you, Anthony.
Hey, Anthony, thanks for having me. I think there's patent war between micro and nitrile. So when you think about copper, as you mentioned, it has a wide application in our daily lives, right? So in addition to copper's on supply and demand, there's also a macroeconomic outlook that can also play an important role to daily price moves. So what we saw recently, for example, earlier last week, we saw that the inventory at a new warehouse dropped down to the lowest level since 1974. Imagine what that means to short sellers who are obligated to deliver a copper or end users who depend on copper. They were at risk of having no copper, so they were forced to the market to buy at a much higher price. That's what drove the copper price surge. And then later on, we saw copper retreated pretty sharply as well. That was because the LME just put on some temporary measures to allow later delivery, for example. And also, the macro concerns about global growth came back again on the driver's seat that weighed down copper price.
OK, so despite this volatility, what are the fundamentals for copper and how tight is the market for this metal versus other base metals?
Yeah, I think that that's very important. When we think about fundamentals versus nitrile. When we look at nitrile, that's really about the story of demand, but a commodity overall is driven by a relative level between demand and supply. So when we look at copper, we are seeing supply has been lagging demand, that's creating a deficit and you are pretty much seeing a new metric joined almost everywhere. Look at the numbers we are seeing inventories sat about 20,000 tonne now at LME versus historical average about 260,000 tonne. So we are still at a record low. It was just overshadowed by a lot of macro headlines. You mentioned about other metals, I would say all base metals are pretty tight. If you look at nickel market, for example, it's seeing similar augmentary risks, right. And look at zinc, aluminum, they are all trading at a pretty elevated level and have been in deficit for quite a while. I do want to mention Anthony, I want a differ copper a little bit from the broader commodities because if you think about copper, it is not is not artificially type, that means it's not like thermal coal, where there's a central power that can influence the market a lot. And also copper, I would say, is the metal most exposed to the secular energy transition. So there are some sector tailwind here.
OK, so given that, what's your longer term thesis on copper?
Yeah. I think given that we are recognizing some near-term headwinds, but overall we are pretty constructive on copper over the long term. So when I hear of questions like, are we too late for a copper play, I would say no. And if I'm wrong, then we may be too early. The reason being that if you look at demand, we have just entered a period of accelerating decarbonization and such synchronized global effort is highly copper intensive. Think about a conventional car uses about 20 kilograms of copper versus EV year that uses about 80 kilogram. That's 4 times right there. And also, what we learned from recent global power shortage is we don't have enough renewables. If you look at from solar panels to wind turbines, they are also a multiple times copper intensive. Then the other side you look at supply. It's probably the more visible because mines are maturing, we are seeing consistently lower copper grades and we haven't put enough money nto a copper project, overlay that with increasing ESG. It's just making that supply start seem more visible down the road. The problem will worsen toward the end of this decade. The question is why we need to worry about this now is because copper protectors take many years to complete. So to narrow that deficit gap because imagery cannot connect it, right? So we need a higher price today to incentivize investment.
So I know that you're very constructive on copper for the longer term, but what are some of the near-term risks or headwinds for some of these base minerals?
Yeah, I think overall the risk is still centered around a macro economy. We talk about COVID. That has been a wild card for a while, but that seems like trending in the right direction. Well, hopefully we can see each other in person sometime, and then we see inflation that is squeezing companies' margins. If that stays much higher and longer than people thought that can dampen global growth. I do want to mention that historically copper itself has been good rightfully speaking against inflation and last, but not least, is China. People worry about slowing China, even collapsing China because of recent headlines about Evergrande, for example, and power shortage. I would just argue both of them are by design. Just because the economy GDP has exceeded the 6% target this year, so that leaves some lost room for regulation tightening. And also, don't forget, the policy makers do have a large toolbox to mitigate systemic risk. And I don't want to underestimate that particular ahead of the 20th National Party Congress later next year. Yeah.
And so for investors who might want to have some exposure to the copper markets, what's the best way to play this market?
Well, I'm not sure it's the best way, but what we are doing is looking at the fundamentals of companies. More specifically, we don't always trust what the company says, but we want them to show me the money, to extend as we want them to have superior ability to tolerate free cash flow. So the chart, I want to refer to this simply, aggregate the eight most liquid global pure copper plays from developed markets, and then we compare our free cash flow yield versus the broader market S&P 500 in this case. So what we see is the sporadic currently is at 5%. Well, what that means is for every dollar we invest in our copper company, we are getting compensated 5% more free cash flow versus the broader market. It's interesting from historical lens because we have been through three up cycles for copper over the past decade, but we were not getting compensated in the same way before. Current premium is just similar to early 2000, when copper really joined a supercycle. But to us it doesn't mean that we can close the eyes and just buy any copper company because year to date, certain names like Freeport can give you like 50% return. Another company can give you double digit loss, so we want to be highly selective here. Another thing we are trying to do is be active, be really active. Our friend Ben Gosic is our expert on our options strategy, for example. So while everyone was super bullish on copper, we were more cautious. But we didn't sit there and do nothing. Ben and the team has been writing put options on a weekly basis just to monetize that market sentiment, market volatility. So we were able to enhance the income at the same time collecting the copper company's shares we like at a lower price.
Jacky, thank you very much for your insights.
Thank you, Anthony.
