Base metal equities to shine in November, Salman Partners says

Stock markets are starting to recognize that they have been under-pricing base metal equities, Salman Partners senior mining analyst Raymond Goldie reasons and investors should “wait two months, then start taking advantage of this trend.”

Goldie, who has covered mining stocks for more than twenty years and has a PhD in geology, maintains in a recent research note to clients that the best way to look at the relationship between the prices of base metal equities on the Toronto Stock Exchange and the prices of the base metals themselves, is to examine the performance of equities relative to that of the TSX Composite.

“The relative performance of base metals equities, relative to that of the equities markets as a whole, is more strongly correlated with the price of the base metals than is the absolute performance of base metals,” he explains. “This implies that the prime driver of the prices of base metal equities is not the prices of the base metals themselves, it is the price of the overall equities markets.” (The same can be said of gold, he adds, because the prime driver of the prices of gold equities is not the price of gold but the price of the overall equities markets.)

In terms of base metal equities in 2010, for example, Goldie notes that they outperformed the TSX Composite by 32.2%, even though the prices of the actual base metals rose by 19.3%. In 2011, base metal equities underperformed the TSX Composite by 14.7% while prices of base metals dropped by 21.7%. And in August of this year, base metal equities outperformed the TSX Composite by 7.7% even though the average price of the base metals rose by just 2.5%, he says.

“We are encouraged that the equities market is showing signs that it has been overlooking the strength and stability in the prices of base metals,” he writes. “Investors who want to join in the equity market’s newfound appreciation of the value inherent in base metals equities should wait until around the end of October.”

In a separate note to clients, Goldie challenges conventional views that there will be a glut of copper next year that some analysts estimate could run as high as 408,000 tonnes.

Goldie argues that the oversupply thesis assumes that copper miners actually make good on the production forecasts they issue at the start of each year. This assumption is wrong, he says, based on compilations by Teck Resources (TSX: TCK.B; NYSE:TCK) that demonstrate that since 2003, copper producers have consistently produced less copper than they had planned at the beginning of the year. In fact, the gap between planned and actual production has averaged 675,000 tonnes a year. “The world produces something like 20 million tonnes of copper a year so that annual gap [averaging 675,000 tonnes] is equivalent to about 4%,” he explains in a telephone interview with The Northern Miner.

“It’s a funny world because before 2003, companies produced more than they said they would,” he elaborates. “It used to be that at this time of year in the 1990s, 1980s, 1970s, 1960s, head office would look at your production figures and if you had a strike or some other event that had affected your production they’d tell you that you were running behind budget and that they wanted you to mine the high grade. But today most of them will say that there isn’t any high grade left that we aren’t mining already. My theory is that there is no high-grade stuff left anywhere.”

Goldie also points to the importance of the copper scrap market as a true indicator of supply and demand fundamentals and claims that scrap copper is in increasingly short supply. He cites figures published by American Metals Market demonstrating that in early 2011, the price of U.S. Refiner’s #2 copper scrap was trading at a US$0.75 per lb. discount to the price of virgin copper on the London Metal Exchange. Today, by contrast, that spread has narrowed to US$0.16 per lb. “That’s the single-best indicator that there is not a surplus of copper but a shortage of copper,” he says. “And if the price of copper goes up, it doesn’t necessarily reflect an increase in demand, it can be just someone playing financial games. But you can’t do that with the scrap metal exchange.”

Finally he argues that China’s copper imports have been growing. According to figures from CIBC published Sept. 10, China imported 388,000 tonnes of copper and related products in August, down 6% from the previous month, but “firmly above the average monthly import levels of 350,000 tonnes over the past two years.”