BMO’s Hamilton on industrial and commodity outlook

Mills at First Quantum Minerals’ 80%-owned Cobre Panama copper project, under construction in Panama. Credit: First Quantum Minerals.Mills at First Quantum Minerals’ 80%-owned Cobre Panama copper project, under construction in Panama. Credit: First Quantum Minerals.

VANCOUVER — Colin Hamilton is the managing director of commodities research at BMO Capital Markets based in London, England. He was previously head of commodities research at Macquarie Group in Australia, and specializes in commodity market analysis, production costs, quality-control techniques, technical analysis, steel metallurgy and cost competitiveness. He recently spoke to The Northern Miner about his global economic and commodity outlook heading into 2018.

The Northern Miner: Looking back at the commodity space in 2017, what went as expected, and what surprised you?

Colin Hamilton: In terms of what went as expected, I’d say we’ve seen another year with a lack of supply growth coming through. Of course, there’s been nobody spending [capital expenses] and we see situations where miners are still very nervous following what I’d call a near-death experience. There’s still a cautious approach out there.

The big surprises for us have generally related to outperformance in China. The demand-side of the equation has been much stronger than expected. I’d also note that China has started to push through pretty aggressive supply-side reforms. We’ve talked about it a lot in markets for a while, and we always thought they’d get there in time, but 2017 was the year where China has accelerated that process. It has changed the entire investment thesis across commodity markets.

TNM: Could you give examples of supply-side and environmental reforms in China?

CH: There are two elements to that story.

First, China is looking at how they’re using the environment and pushing through aggressive policy measures. They’re dealing with the fact that they’re viewed as heavy processors of raw materials and a very polluted country. The environment is the one thing the Chinese government is judged on basically every day. What they’ve done is make it harder for the private sector to operate in many markets. Some of the smaller producers have found it very hard due to higher regulations and falling access to capital. So the market has lost that elastic buffer it had in terms of Chinese domestic mine-side response.

The second element is the supply-side reform agenda. The model for commodity markets over the past 15 years has basically been that China buys raw materials — and it has more than enough processing capacity — then it would export you a good amount of the finished product as a deflationary pressure.

This year marked the first time we saw them shut down operating steelmaking capacity. They have said that aluminum is now ‘one in, one out’ in terms of new capacity. Suddenly we’re not getting that Chinese refined capacity addition we’d become used to in the market. We’re also consequently getting fewer exports from China. If you project all that forward it suddenly appears we could be looking at a situation where some of these markets reincentivize ex-China capacity.

TNM: There’s a lot of talk about the potential for rapid growth in electric-vehicle (EV) production and the resulting impact on demand for  technology metals. What do the  fundamentals look like to you?

Colin Hamilton, managing director of commodities research at BMO Capital Markets. Credit: BMO Capital Markets.

Colin Hamilton, managing director of commodities research at BMO Capital Markets. Credit: BMO Capital Markets.

CH: It’s definitely more of a narrative story at the present time, but it’s become mainstream in terms of future projections. Now EVs are just over 1% of global sales, but expectations are for that to grow anywhere from 5% to 15% by the middle of the next decade. It has the potential to become a very real story.

And the mining industry has clearly been looking for a post-China growth story. For markets it can have an impact sooner rather than later, for example cobalt and lithium, but it’s still at the margin for commodities like nickel and copper. But mining companies with a longer time horizon like to focus on that potential.

TNM: There appear to be compelling supply constraints for copper. What is your view on the mid-term fundamentals for copper?

CH: Commodity analysts have been saying that supply-side cliff for copper has been three years away for the past decade. But now I’d say we’re probably 18 months away from that scenario.

Freeport-McMoRan’s (NYSE: FCX) Grasberg operation — the second-largest copper mine in the world — is scheduled to hit peak production next year. Meanwhile, First Quantum Minerals’ (TSX: FM; US-OTC: FQVLF) Cobre Panama development will also come online in 2018, and that’s basically the last of the true megaprojects commissioned during the last cycle. In addition, we’re seeing solvent extraction and electrowinning copper production peaks in our numbers in 2019 … you’ll see that supply-side copper conversation hit high gear in 2019.

The demand-side of the equation for copper is an interesting one because it’s quite unlike a lot of the other industrial metals. For example, the steel market has big cycles as economies industrialize.

With copper you tend to see steadier demand-side growth over time. We’re running with demand growth of 2.4% per annum globally over the next five years. That’s slightly above trend, but it’s more to reflect the fact that we need a lot of distribution grids rebuilt around the world to prepare for EVs. That’s a very copper-intensive process.

TNM: Nickel is receiving more attention as people talk about green energy and EVs. Is near-term nickel more of a supply-side or demand-side story?

CH: It’s certainly more of a supply-side story right now. The demand for nickel has actually been above many other base metals over the longer term, but that’s more due to stainless steel than anything else.

I’m probably more cautious on nickel over a five-year period than I was at this time last year due to Indonesia relaxing its ore export ban.

That means the Chinese stainless steel industry has a ready supply of nickel ore. There’s no raw material constraint in the market anymore, and the nickel price is essentially set by the price of pig iron in China, in my view.

With the situation in Indonesia I can only see that price heading lower.

Longer term, you’ll see bifurcation in the nickel market as you get growth from non-stainless steel applications.

Of course, we expect battery technologies to lead the way as cathode chemistry becomes more nickel-rich over time.

But it will take until the middle of the next decade for that to come through from a fundamental perspective.

What would actually make me more positive on nickel? If some of the higher-cost, class-one nickel suppliers were actually left in the ground at the moment, that would accelerate the process.

Maybe miners could take a look at their portfolios and say: ‘Hey, this could be worth more in 10 years’ time if I leave it in the ground.’

TNM: We’ve heard a lot about zinc over the past 18 months due to the  price rally. How do you see zinc heading into 2018?

CH: Zinc has been a great story from a commodity perspective. It has played out like it should. We had mine supply falling, refined output falling and stocks being drawn down.

We’re seeing a tight zinc market today. However, no one wants it to go higher at this point. Obviously consumers don’t want any further price increases, but I’d also say producers are getting nervous about demand destruction. That kills the medium-term story.

We’ve also seen a supply-side response at the mine level. Not from China, as we discussed before, but actually from smaller assets in Peru, production restarts, and greenfield stories.

I don’t want to say zinc is in the rear view already, but now it feels like we’re struggling to find that next catalyst for upside.

Of course, zinc could spike because it’s very inventory light on the exchanges, but I wouldn’t view that as sustainable.

The best thing for the producers in the market might be a period of consolidation around this level, and I’d say the risk-reward thesis is now starting to shift towards the down side.

TNM: How are you seeing uranium markets in 2018?

CH: It has been a frustrating market for quite a while. We’ve been waiting for these industry leaders to take the steps needed to control supply.

The current market is awash in inventory globally, and it will take a sustained period for those inventories to draw down.

We’ve finally seen big production cuts, and we’re looking at a situation where we can start to run down the inventory.

The question now becomes: When do utilities worry about the situation a bit more? At the moment they’re well supplied with adequate inventory, but they can see the production cuts potentially extending through 2018. That will make them pretty nervous.

It all signifies that we’re past the bottom of the cycle for uranium. We had that period where spot prices were at about US$20 per lb., and the real uranium price over the past 40 years has fallen by 95%. But it feels sort of like where the potash market was 12 to 18 months ago, where the big producers exerted some discipline in the industry. That tends to signify a bottom.

We see upside in spot uranium pricing as utilities get a bit more nervous, but it’s hard to see the market go back to the levels that would incentivize new production and tonnage. That’s a long way off.

TNM: How do you think about mining companies and their equity values. And what do you hear from the mining executives themselves?

CH: It’s pretty interesting. I’d say there’s still not as much generalist interest in mining equities as we thought there might be — particularly considering the free cash flow yields we see come through from some of the miners.

The cyclical indicators seem to show there still isn’t that belief there.

I’d say there are still fears around China and the demand-side story. In our view, the mining equities still have a lot of catching up to do as people realize that the global industrial economy is in good shape for now.

I think you will see that general rotation back into mining and metal investments, which will obviously benefit the equity.

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