How to Invest in Copper Stocks
Copper is one of the most versatile metals. It runs through our homes as part of both our plumbing and electrical systems. It’s a key component in our cars, which contain an average of 44 pounds apiece, including nearly one mile of copper wire. The metal is also an important building product, part of our money supply (it coats the penny), and essential for telecommunications.
Given its versatility and importance for so many industries, the global economy uses an increasing amount of it. In 2018, worldwide copper consumption hit 23.6 million tons a year and should reach 29.8 million tons by 2027. While recycling old copper helps meet about 45% of global demand, rising consumption requires continued development of new copper resources.
That rising demand has the potential to boost the price of copper in the future, which could drive up the stock prices of companies that mine the metal. That makes it an intriguing industry for investors to get to know. With that in mind, let’s take a look at how to invest in copper stocks.
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An overview of the copper industry
Copper is one of the most abundant metals. According to an estimate by the U.S. Geological Survey, the earth contains more than 8.1 trillion pounds of copper. We have only mined about 1.1 trillion pounds of copper so far, most of which is still in use due to its recyclability. That leaves plenty of available copper resources to meet future demand.
The problem, however, is that only a small fraction of the earth’s copper resources are economically viable to mine at present-day prices and using current technologies due to reserve quality. For a copper resource to be commercially viable, it needs to contain a high concentration of copper ore, which is copper in its natural state. Most top copper deposits contain between 0.5% to 1% of copper ore.
There are two main types of copper ore: Oxide and sulfide. Copper oxide is more abundant closer to the earth’s surface but is typically a lower-grade ore due to less concentration. Because of that, mining companies need to extract and process more ore to produce the same amount of pure copper, which is known as a cathode. Copper sulfide deposits, while less abundant, contain higher amounts of copper. However, it’s more expensive to process copper sulfides, making it less economical than oxides in producing copper cathode.
Companies usually use an open-pit method to mine copper, which as the name suggests consists of digging a large hole in the earth to extract the ore from rocks. They drill holes into the ground and insert explosives that break apart the rock. The boulders are then hauled away where they’re crushed down to the size of golf balls. From there, oxide ores go through a three-step process known as hydrometallurgy that uses water-based solutions to extract and purify copper to create a cathode. Copper sulfides, on the other hand, go through a four-step process known as pyrometallurgy that uses heat to create a pure copper cathode. From there, it gets shipped to end users that transform it into a variety of useful products such as wiring and piping.
Many companies produce copper, either as their primary focus or as a secondary product. The five largest copper companies in the sector, as measured by their copper reserves — which is the known copper resources underground — are on the following table:
Data source: Southern Copper investor presentation. Note: Reserve data as of Sept. 5, 2019.
While all five of these companies produce significant amounts of copper, only Codelco, Southern Copper, and Freeport-McMoRan make most of their money on this versatile metal. BHP Group and Glencore, on the other hand, are much more diversified miners. Because of that, BHP’s largest profit contributor was iron ore in 2018 at 39% the total while Glencore’s top earner was coal at 33% of the total that year.
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Key industry metrics
Investors who are interested in the copper mining sector need to learn several key terms to better understand the industry. Here are five of the most important ones to know:
Ore grade: An ore grade measures the percentage of copper oxides or sulfides in a rock. A commercial copper deposit will usually contain between 0.5% to 1% copper ore as well as other metals and such as gold, silver, molybdenum, lead, and zinc. While higher ore grades typically suggest a mine is more valuable, that’s not always the case. That’s because ore type (oxide vs. sulfide) and consistency of the resource also factor into a mine’s ability to produce economically viable copper.
By-product credits: A by-product credit is a cash payment that a mining company receives for producing another metal as a by-product of mining its primary target. For example, most copper mines contain small quantities of other raw minerals that a miner will sell to another company for processing. Southern Copper, for example, produces zinc, silver, and molybdenum at its copper mines. It sells these raw products to help offset the cost of producing its primary target, which in this case is copper.
Net cash costs per pound: This metric measures what it costs a miner to produce a pound of copper after factoring in the benefits of the by-product credits. For example, it cost mining giant Freeport-McMoRan $2.05 per pound to produce copper out of its North American mines in 2018. However, because these mines also produced some gold and silver, Freeport-McMoRan was able to sell those precious metals in their raw form to other miners for processing. The by-product credits it received from those sales helped reduce its net cash costs by $0.26 per pound to $1.79 per pound of copper, thereby improving the profitability of its mines. In the 2018 to 2019 time frame, copper traded at an average market price between $2.50 and $3 a pound.
EBITDA: EBITDA is an acronym that stands for earnings before interest, taxes, depreciation, and amortization. It’s a non-GAAP metric that measures an asset’s underlying earnings. Miners highlight this metric because they often record large depreciation expenses as they deplete the reserves of a mine, which reduces their net income. Southern Copper, for example, reported $1.5 billion of net income in 2018, which was well below the $3.6 billion of EBITDA it produced. One of the factors causing that difference was that it recorded $674 million of depreciation, amortization, and depletion expenses that made it seem like the company made less money than it actually did that year.
Debt to EBITDA: This ratio measures how much debt a company has compared to its annual earnings. Ideal debt-to-EBITDA ratios vary by industry. Miners typically like to have this ratio below 1.0 times due to the volatility of commodity prices.
Headwinds facing the copper industry
Copper demand tends to be economically sensitive since it’s a key material in the construction industry as well as for consumer goods like cars and electronics. Because of that, when the global economy slows down, copper demand follows suit, which also weighs on pricing.
The Chinese economy is particularly important to the copper market since it was the largest copper consumer in the world at 49% of the total in 2018. Thus, when China’s economy slows, it can have a significant impact on copper prices. That’s why inventors who are interested in the sector should keep an eye on things that could impact this economy, such as trade disputes with major partners and slowing export growth.
Another major issue facing many mining companies is labor unrest. The copper mining sector alone had six notable work stoppages in the decade from 2009 through 2019. Chilean copper giant Codelco, for example, had production at its key Chuquicamata mine disrupted for two weeks in 2019 after workers at the site went on strike. This dispute was over pay and the start-up of a new underground section at that mine. The state-owned company had to increase wages and other benefits to get workers to approve a deal. As a result, the strike cost it money not only during the production curtailment from the work stoppage but also after that from the higher labor costs. Because of how much these disputes can impact miners, investors should look for miners with a history of positive labor relations.
Governments play a key role in regulating the mining industry. That authority helps keep mining companies in check so that they don’t destroy the environment or exploit the local population. This government oversight can also be an issue for mining companies. That has been the case for Freeport-McMoRan in Indonesia. For years, the company had controlled the Grasberg mine, which contains one of the world’s largest copper and gold deposits. The government, however, wanted that strategic natural resource under state control. After years of disputes and production stoppages, Freeport ultimately agreed to sell a majority stake in the mine to a local company. Given the potential issues with government intervention, investors should look for miners that focus on regions where there is a clearly defined regulatory framework to operate within.
With copper demand expected to rise, the industry needs to invest in increasing its capacity. But building new mines is costly, with Freeport-McMoRan estimating that a greenfield project requires copper prices in the range of $8-$10 a pound to be economical. That’s due to the massive up-front investment in infrastructure, permitting, and equipment required to bring a new copper mine on line. Therefore, the industry won’t be able to greenlight very many major new mine developments until copper prices improve to the needed levels, and its main focus will be on expanding existing mines, which somewhat limits the sector’s growth prospects.
Copper mining requires lots of water to turn oxide ores into cathodes. However, due to environmental concerns, miners are facing increasing pressure to reduce their fresh water consumption. Consequently, they have to recycle water and invest in desalinization projects to use more salt water, which add to mining costs.