An interesting article from an Aussie analyst in covering a wide...

An interesting article from an Aussie analyst in covering a wide range of macro issues and impact on the base metals:

Base Metals Basing BY RICHARD CAMPBELL - 03/10/2014  
Almost all industrial metals have fallen since the iron ore exporters decided to commit hari-kari, but prospects for lead, zinc and bauxite are basing rather than slumping and for $A producers are in many cases firming.

Even the currently well supplied copper market has fundamental support as conventional electrification spreads in the developing world and the urgencies of climate change and economic nationalism add either demand support or supply constraint.

Alumina price and company firming
The contrast between the ferrous market and base metals is captured by Alumina. As BHP, Rio and FMG fall below 12 months lows AWC is at a three year high and rising. The half year result was negative after extraordinary items, but as spot sales climbed to 80% of revenue, the market decided to look through the blemish of the $245m write-off of its Point Henry smelter.

This may seem like a lot of looking though, but the market dynamics for aluminium and bauxite are swinging from glut to stability. As with steel, cement and almost every Chinese heavy industry, its 38 aluminium refineries are far in excess to demand, but as with China’s over-production of solar panels which destroyed companies and slashed panel prices globally, the down-stream effect has been stimulatory, encouraging not merely experimentation, but changes in attitude. Some manufacturers are embracing the benefits despite the higher cost. Pound for pound it is stronger than steel, non corrosive and absorbs shocks better, but tightening US vehicle emission regulations are the real game-changer.

Ford’s F-150, a chunky pick-up lost 300kg when slimmed down in an all-aluminium model while a concept version of a family sedan, the Fusion, shed 360 kg giving a family sedan the 40mpg fuel efficiency of light cars. The biggest seller in the US, the Camry, is starting small with just engine hoods and panels, but Industry research says 75% of US pick-ups will be all-aluminium in 5-6 years. The change may be quite profound: lighter bodies allow smaller and lighter engines. Hindalco’s US subsidiary Novelis is expanding to meet what it believes could be a $6-7 billion auto aluminium market.

While internal Chinese demand is likely to rise as it moves into high volume aircraft construction and lifts canning volumes, the feedstock required, low-silica bauxite is not abundant in China. As a result it has been importing 40% of its bauxite, but a hammer blow came in January 2012 when Indonesia imposed a 20% tax on bauxite exports and then a year later a complete ban was imposed and a 50% tax. As China was importing 70% of the 40% from Indonesia, it had to find 48mt of bauxite elsewhere. In terms of final aluminium this translated to 10mt, or 20% of global production. This is almost the reverse of the ferrous supply situation where supply continues to burgeon. Rio is opening a new mine with 16 year life which will test the old saying, “Be careful what you wish for”.

To be the last man standing when China’s base demand for steel may be significantly lower than most research expected may be a hollow victory especially now that India is about to reverse bans on exports of iron. This reversal over-rides previous concerns about displacement of villagers and environmental despoliation.

Resource nationalism
Indonesia is going in the reverse tack. Its resource nationalism may appear irrational when the world is over-supplied with smelting capacity, but from a broader perspective the capture of processing margins and jobs in Indonesia makes sense. Indonesia is large domestic market in itself and regrets the oil Royal Dutch Shell exported before independence.

Whatever the merits economic nationalism, it bodes well for some of the junior bauxite hopefuls like Bauxite Resources and Australian Bauxite.

Bauxite Resources is well located near the WA smelters just 60kms north east of Perth and claims several low-silica deposits which make a “world-class” project close to rail and ports and the resources on private land. This region produces 20% of the world’s aluminium.

Australian Bauxite (ABX) has been exploring for four years in NSW, Queensland and Tasmania and has also built up an extensive portfolio of low silica gibbsite which requires lower temperatures and less caustic soda. In many cases the deposits are close to or actually adjacent to little used country rail lines. Tasmania is desperate for activity. It does no harm for ABX to have a former Premier on the Board.

Nickel market deficits ahead
The impact of economic nationalism on the nickel price has also changed market dynamics. When the Indonesian ban was imposed nickel rose 45% from February to June revealing how much the market depended on Indonesia’s low grade laterite ore. The ban sent stocks like Sirius running until the early September break in spot iron ore which stopped the rise in its tracks.

While nickel is now back below US$8lb the $A price of $19,000 a ton is relatively high for companies with grade and volume like Sirius. Vale, the owner of Inco and the huge Voisey’s Bay nickel deposit has entered the field near the Sirius tenements. Poseidon’s purchase of Norislk’s Black Swan nickel mine and ore body also looks timely. Black Swan has been moth-balled since 2009, but now provides a very low cost plant for Poseidon’s re-furbished Mt Windarra mine. The company is nothing if not bullish and quotes Wood McKenzie, the global resources consultant which forecasts that even without the Indonesian ban nickel will be in deficit for a decade.

Lead and zinc supply lags
There are no major interventions like this in the lead and zinc market other than generally tightening environmental regulations. As many projects are multi-metal and increasingly small, the risk of delays make explorers cautious about sinking dollars in the ground. Raising funds for exploration is now very difficult and usually very dilutionary. Even those that snag something with potential no longer have as many eager Chinese state owned companies or metals institute ready to offer capital. Our banks and funds won’t go near anything that hints of risk in conventional business, let alone mining,

Consequently there is no replacement yet for MMG’s large Century mine which has one year of economic ore remaining. Dugald River to the south had promise, but its geological issues are still to be resolved. On-going exploration in the region has turned many sniffs, but the scale required means large dollars which fewer and fewer have.

Even big Glencore is wavering. The owner of the mighty Mt Isa lead-zinc-silver deposits is considering a super pit to increase the copper content of the main ore body, but without this large expansion, Mt Isa may close by 2021 after 85 years of production.

It is not so different in North America. After 44 years of production the super-giant Brunswick #12 closed last year. Canada has several lead-silver-zinc provinces outside the New Brunswick region, but they are remote, expensive to operate and as with all metals are tending to be lower grade for the obvious reason that apart from rare exceptions, the largest and richest ore bodies tend to be exploited first.

Geo-political constraints
Another restraint on supply is turmoil in the Middle East. There are numerous base metal deposits across Turkey, Iran and North Africa etc but, money centre fund managers are not breaking an arm to risk their funds in the MENA region as borderless terrorisms spreads.

Terramin is a case study for the new geo-political reality. It has a 65% interest in Tal Hamza, one of the world’s larger mid-grade lead/zinc projects. This project has an almost ideal physical location just a few kilometres from a deep water port in the Mediterranean, but the moment may have passed for decades. Tal Hamza had mining complexities, but also interfering local authorities who delayed and prevaricated rather than helping. Gradually these issues were resolved and the pathway seemed clear with a new mining code and renewed government support, but now, after the beheading of the French tourist not far from this district, the prospects of Tal Hamza have dimmed. The beheading captured headlines, but it was far from an isolated event. In the last decade 80 villagers in the surrounding district have been kidnapped for ransom and three killed by what is now an affiliate of ISIL. Risk advisers will be quick to tell fund managers that Algeria was also where almost 50 people were killed last year by a related terrorist group who attacked a gas facility. There are a number of Terramins with less than perfect base metal projects facing hurdles like grade, mining complexities, stiffer environmental penalties or simply distance, but for those still standing this is the opportunity.

Prices can move sharply if inventories shrink to days and weeks. Another dimension in assessing possible supply shortages in coming years is moderation of China’s risk appetite after some unwelcome experiences in Africa and Australia. It is one thing dealing with African politicians and their cronies, but an existential shock to encounter a Clive Palmer. Citic’s losses in Australia are staggering even in China’s terms.

China fails to meet ISO coating standards
The flip-side of bungled and bad investment experiences is that demand for some metals remains firm in China. It was big news when China equalled the highs of US auto production in 2012 but two years on it is nudging 22 million units a year which is drawing down a lot of lead for batteries and zinc for coatings of automotive steel.

If China expects to export its excess steel as coated steel products it will also need to use more zinc. One national authority has evaluated China’s galvanized products and found they use a third to a half less zinc per square metre than the ISO standard and so will rust within two years. Several countries including Australia have raised anti-dumping tariffs against these products at rates of 30-40%.

Higher standards are also required internally. Visitors to China who stray into be back streets are immediately struck by the rust stains on even relatively new offices and apartments. The director of research of China’s national Ministry of Housing has said that most of the buildings constructed between 1949 and 1979 were intended to be short-lived. There was an urgency to rebuild after both the civil war and the war with Japan, but now the 50 year life-span of these buildings had long past. He added that the current wave of construction was often little better as development profits were placed far ahead of sustainability and capital efficiency.

Copper weak short term, strong mid and long term
For copper the picture is dimmer short term, but potentially strong mid-term. While LME stocks are well below the five year average they are rising and a recent lift in pricing has been followed by weakness as supply kept coming and as China’s demand slowed.

At just a notch above US$3 lb it is below the five year average of US $3.40-3.50. Analysts remain divided about the how the supply demand will play out over the next 2-3 years. While it is seems self-evident that copper has a strong long term future as India, Africa and South America move up the rankings of copper consumption per head, re-development of some of the major Chilean mines has prolonged their future. The giant Chuquicamata has been producing in the modern era for 120 years and before that for 2000 at least, but a slated closure has been postponed as the mine goes under-ground. It is still pumping out over 500,000 tons pa.

The world’s largest copper mine Escondida has had been worked down from high grade to lower over 25 years and is now running at slightly less than 1% at higher cost as it goes into deeper ore. Grasberg in Papua is much the same. Grade has been falling, but it will have a second or third wind with block caving beneath the pit.

Greenfields projects have also arrived like Mongolia’s Oyu Tolgoy. Again a monster resource, after many delays it is now up and running at 100,000 tons a quarter. Peru is also keen to follow Chile as a copper major and now with the two Chinese copper majors controlling two of the largest Peruvian mines, Peruvian copper output is likely to double by 2016 to 2.8mt or about 15% of world supply.

China’s copper appetite still large Copper bulls like Rio can still make a strong case for as China continues to install underground rail systems in second and third tier cities, builds more wind farms and mandates electric vehicles for 30% of government car fleets. There is even a grand plan to create two mega conurbations in the south and north with rail links to join the cities of the Pearl River delta and a similar linked city plan on the northern plains. Beijing would be joined to Tianjin, Tanshan and Baoding with multiple rail tracks like the four parallel tracks which link Schenzen with Guangzhou: two down, two up and all four high speed. China’s “social housing” program will absorb thousands of tons of copper. It may seem bizarre that with 46-50m apartments empty, China is preparing to construct 36 million smaller affordable units, but this is the case. Developer profits will be capped and subsidies granted to relieve over-crowding in the large cities, particularly Beijing.

But the fact that power demand is slowing and that State Grid Corporation is being audited is not helpful. The State Grid is the single largest user of copper globally and had planned to lift investment 12-13% this year so may make a big contribution, even if it does join the long list of state owned corporations whose senior management have stood down or investigated for embezzlement. Recent news that Beijing will put ceilings on local government debt and not bail out failed loans is also a negative. Numerous attempts to rein in cities and provincial administration from grandiose projects have failed. Projects will now be vetted and many stopped. This will impact on demand for cement, steel, glass and base metals.

The sleeper, however, is China’s massive expansion of wind power. It already has 75GW installed much of it in far west in the desert basins of Xinjiang where the wind resource is immense. This is already a quarter of the world’s wind power capacity, but barely 2% of China’s power consumption. The plan over the next six year is to triple output to 200GW with the capacity to erect two towers a day. Each turbine consumes 1500-2000 kilos of copper in wiring and cable but the transmission lines connecting Xinjiang with the eastern cities will consume millions of tons. That still leaves 55% of consumption outside China where demand may be spurred by the on-going electrification of rural India and refurbishment of its ageing urban grids.

Resurgent home building in the US also draws down big volumes. The average build takes take about 200 kilos of copper in wiring and pipes, before the locks, alloy door-handles etc. At a rate of 400,000 new homes p.a. that’s a lot of copper. Copper usage in cars is also climbing: a conventional car uses about 15kg; a full electric takes 60kg. The next big applications include anti-microbial surfaces for hospitals and door handles. Fish nets made of copper alloys don’t attract growth. As fish stocks collapse in the oceans, nets may be a sizeable market. For the long term copper looks robust as climate change forces more rapid expansion of copper dependent renewables like more wind farms, solar panels, efficient air conditioners and micro-grids.

For Australian copper producers there is no immediate joy, but equally no great misery either as the $A bounces around on either side of 87c with 85c now very likely. At the current $3.07lb that translates to A$3.50. This is no great bonanza for some, but for a Sandfire with cash costs running at $1.15-$1.25 it is not half bad.

For emerging copper players like KGL Resources or Kidman with their multi-metal projects, the credits from relatively high grade lead and zinc should provide insulation. Before a pending pre-feasibility study it is too early to say whether KGL’s shallow and consistent multi-metal ore at Jervois will allow the copper to be mined “for free” by the zones of high grade lead and silver with useful zinc and gold but in terms of metal in the ground there is a value gap of distended proportions. KGL’s in-ground JORC copper resource in $A terms is now $2.2 billion. This is a very crude measure, but when average copper is 1.5% with many intersections of more than 5% the capitalisation of $30m plus cash look anomalous. Throw in the other metals and it resource is closer to $3 billion.

The market seems to anticipating a shocking collapse in China’s copper appetite while discounting the high grade lead to less than zero. Alternatively this is yet another case of massive misjudgement. In the face of repeated warnings from Chinese steel specialists, the Pilbara miners rushed ahead with supply. Vale was even bullish, but with a claimed cash-cost of $22 a ton, it will be the last man standing in iron ore, not Rio. The owners of Escondida are unlikely to make the mistake with copper. If they over-produce to ruin other suppliers, they go down as well. Some junior miners will be praying they do. If Escondida is moth-balled, the copper price soars.

http://www.*********.com.au/richard_campbell.asp?a=AV&ai=31974