Gold gets plenty of attention, but the outlook for base metals like copper is also positive in 2021. RBC Capital Markets analysts raised their 2021 average price estimate from $3.25 to $3.50 a pound due to higher consumption estimates. They expect copper consumption to be higher this year due to indicators that the economy is strengthening.
In a recent report, analyst Sam Crittenden and his team said the backdrop for copper remains positive this year, while low inventories support higher prices. However, they expect the supply response throughout the year to be gradual from both mines and scrap. These factors could moderate the copper price.
Copper equities also remain well-positioned in 2021, and the RBC analysts are starting to see multiple expansion as investors become more interested in the sector.
They note that North American base metals stocks have traded at an average EV/EBITDA multiple of 5.8 times over the last decade. On the other hand, the TSX index trades at a multiple of 9.2 times. Currently, North American base metals stocks are trading at a multiple of 6.9 times, while the TSX is at a multiple of 12 times.
The RBC team said there had been significant multiple expansion elsewhere, based on consensus estimates from Bloomberg.
They add that copper miners should trade at a discount to the market. However, as their free cash flow yields improve, and they increase discipline around growth projects and M&A, they believe a higher multiple is justified.
Factors Boosting the Copper Market
Crittenden and his team cited four big drivers of the copper market in 2021. The first is China, where consumption has been healthy, underpinning demand while the rest of the world catches up. They expect the strength observed in 2020 to continue this year.
Second, they believe copper inventories will remain low, which supports higher prices. The RBC team projects that exchange inventories will continue to decline. They were down 1.3% to start the year and have fallen 60% since peaking in March 2020. These trends indicate tightness in the physical copper market.
Third, the RBC team noted that spending on green infrastructure supports a bullish outlook for the medium term. They expect electrification to offset the eventual decline in demand growth in China. In the U.S., Democrat wins could pave the way for accelerated infrastructure spending. However, the RBC team also says that it could take years to see a tangible impact on metal demand.
Finally, Crittenden and his team said the positive macro environment also supports higher copper prices and could boost miners. RBC Elements’ predictive copper model suggests a copper price of around $3.50 a pound this year. That price is based on current macro inputs like strong equity markets, a weaker U.S. dollar, strong investment demand and lackluster supply growth.
The Importance of China
The RBC team explained that China consumes about half of the world’s copper, which means there has been a strong link between copper consumption and industrial production in China since 2013. They believe copper demand fell 3% last year and will grow 4% this year.
Chinese manufacturing PMI fell to 35.7 in February when Beijing initiated lockdowns. However, it has been above 50 in each month since then. Last month, Chinese manufacturing PMI stood at 51.9. Thus, the RBC team believes copper demand has returned to trend.
They added that exports from China remain healthy, which suggests strong demand for manufactured goods. Apparent consumption has rebounded and remains strong, while imports of concentrate and scrap are falling, squeezing refined metal.
Further, the RBC team said copper consumption in key end-use categories has also rebounded in China to fall in line with 2019 levels, except for grid investment.
Projecting Copper Prices for 2021
They also noted that copper prices have been moving in step with the equity markets since the beginning of last year. The commodity has a correlation of 0.91 with the Shanghai Composite and 0.89 with the S&P 500.
The weak dollar has been good for copper, as the metal has had a -0.58 correlation with the dollar index since 2016. Further, the recent weakening in the dollar has occurred alongside the strengthening in copper prices.
Valuing the Equities
The RBC team said valuations are above where they were before the pandemic started early last year. Freeport-McMoRan (NYSE:FCX) and First Quantum Minerals Limited are trading at a premium to the rest of the names because they are expected to grow this year. Crittenden and his team added that copper stocks aren’t expensive by historical standards based on spot prices, but there could be a correction if copper prices weaken.
They note that base metals equities are up 109% since the beginning of last year, while copper is up 30%. Capstone Mining Corp, Freeport and First Quantum are the best-performing stocks in the group, with 279%, 130%, and 97% gains, respectively.
The RBC team sees room for multiple expansion as free cash flow improves and funds flow back into copper miners. They add that mining stocks usually trade at a discount to the broader market due to volatility in commodity prices, operational risks and mining’s intensive nature. However, Crittenden and his team add that going into what could be a time of strong commodity prices due to economic recovery, there could be room for multiple expansion.
At spot prices, North American copper miners are generating strong free cash flow. Capstone and First Quantum have the highest leverage to copper prices, while capital expenditures related to the QB2 expansion are impacting Teck Resources Ltd’s (NYSE:TECK) free cash flow this year.
Stocks to Consider
Morgan Stanley analysts also released a report on copper stocks this week. They said copper stocks could surge this year and that a buying opportunity could be here soon. The Morgan Stanley team said volatility could arise around the Chinese New Year, presenting that buying opportunity.
Their top picks for mining and commodities are Glencore PLC, Lundin Mining Corporation and First Quantum. Although the companies posted substantial gains last year, the Morgan Stanley team still sees attractive opportunities. They said the bullish macro drivers would boost the companies’ “tight fundamental picture.”
The Morgan Stanley team sees 67% upside for Glencore, 34% upside for Lundin, and 31% upside for First Quantum. They see upsides of 93% for Glencore, 61% for Lundin, and 54% for First Quantum if prices reach their bull case of $4 per pound.
On the date of publication, Michelle Jones did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Michelle Jones is editor-in-chief for ValueWalk.com and has been with the site since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Email her at Mjones@valuewalk.com.