How a Landslide Shifts Copper Supply

The U.S. mining industry was dealt a devastating blow as Kennecott Utah Copper’s Bingham Canyon Mine experienced a pit wall failure causing a massive landslide with rocks and dirt covering the bottom of the mine pit. It’s a miracle no one was hurt due to the vigilance of its owner, Rio Tinto.

Brian Hicks, portfolio manager of the Global Resources Fund, is very familiar with the mine, having visited it often. He also has personal ties as both of his grandfathers were once employed by the mine. When Brian saw the photo of the landslide posted on the web, he said the substantial destruction of the collapsed wall and falling rock was apparent, yet the tremendous scale and magnitude of the mine cannot be captured in pixels.

Bingham’s immense size is a powerful sight to witness firsthand. It is one of the largest open-pit copper mines in the world, it’s the second largest copper producer in the U.S., and it’s been in operation for more than one hundred years.

The mine supplies about 1 percent of copper to the global market, says research firm Paradigm Capital. In the fourth quarter, the mine produced 59,000 tons and 163,000 tons in 2012. Because of the landslide, analysts expect there to be a huge decline in the overall copper output from Bingham this year.

This is a short-term setback for Rio Tinto, as the mine is one of four main copper assets for the company, but Nomura sees an additional shift in the copper market, “where this could take a market where many observers felt a meaningful surplus was about to emerge, back to remaining quite tight” in 2013.

Copper production had been rising to a new high, as you can see below. Credit Suisse charts the rising supply of copper coming out of Canada, Chile, China, Mexico, Peru and Zambia, which represents 60 percent of global supply. In the fourth quarter of 2012 only, copper in the top 6 countries increased 8.5 percent on a year-over-year basis.

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With production higher, copper has moved from a deficit to a balanced market, which is typical, but “this is not to say that persistent growth of new mine supply is not problematic for a variety of technical and other reasons,” says Credit Suisse. In addition to the setback from Brigham, the new mines under development, including one in Mongolia, might not come on line as quickly as one thinks.

Copper mining has always been dealt more than its fair share of challenges: We’ve discussed labor disputes in the past, such as the massive strike in Grasberg in Indonesia, which significantly reduced production from a pre-disruption level of about 500 to 700 tons to 136 tons in a year, says Credit Suisse. Political issues and weather catastrophes have also hurt copper supply in recent years.

The good news is that demand for copper persists. With four babies born every second, a growing population along with rising urbanization will continue to drive the need for copper.

The red metal is also the most widely consumed base metal, dominated by wire and cable and used in anything that is electrical or electronic. Credit Suisse estimates that about 20 percent of overall copper is made into building wire and construction uses make up almost 30 percent of the world’s copper use.

Another growing use of copper comes from hybrid and electric cars. Many countries, including China which already uses 40 percent of the world’s copper, have been encouraging residents to purchase hybrid and electric cars via subsidies. These fuel-efficient cars consume substantially more copper than an automobile run on gasoline. Whereas a gasoline-fueled car uses 50 pounds of copper, an electric car can con sume triple that amount, says the Copper Development Association. I often say, there’s no free lunch on the commodities table: If more hybrids fill the roads, more copper will inevitably be needed.

The landslide in Utah is just one example of how quickly and unexpectedly the supply and demand factors facing the red metal can shift, which I believe underscores the need for nimble active management.

A New Penalty for Playing by the Rules

Taxpayers who save and invest may soon be punished for doing the right thing and investing successfully. In President Barack Obama’s budget proposal, he wants to limit an individual’s total balance in tax-favored retirement accounts to $3 million for someone retiring in 2013. The president feels the need to “define for everyone what is ‘needed’ for a ‘reasonable’ retirement,” says the Wall Street Journal.

For years, the financial industry has been actively educating and encouraging investors to take full advantage of their tax-advantaged 401(k)s and IRAs. “Now He’s After Your 401(k)” says the WSJ, as its headline draws attention to the contradictory message the government is sending to investors. Rather than incentivizing and rewarding hard-working Americans, the policy penalizes “people who work for decades and abstain from buying the bigger house or the new car so they can contribute the maximum to their 401(k)s or IRAs.”

Having the will and thrill to invest is part of the fiber that makes America great. The proposal “undermine[s] a key national priority—helping Americans prepare for a secure retirement,” says the Investment Company Institute in agreement.

I believe the government hindering savers and investors is the equivalent to a referee kicking Miami Heat’s LeBron James out of a game after he’s scored a “reasonable” number of points.

If you have been dutifully paying your taxes, scrimping and budgeting to save and invest in your future, voice your opinion on the budget proposal. Contact your representatives in Washington and tell them to refuse a strategy similar to the socialist policy wonks in Europe who implement anti-saving and investing policies, oblivious and insensitive to the unintended consequences that hurt savers and investors.

Thank You for Sharing Your Best Investment Advice

A few weeks ago, I talked about my best investment advice in a blog post and asked readers to share the best investment advice they ever received. The responses were overwhelming!

Many people shared their learnings from relatives or professors. Others have heeded the advice of well-known investors, such as Warren Buffett. I was heartened by the fact that many of our readers share our belief in the importance of diversification and accepting the concept of balancing risk and reward as these ideas will serve them well over the long term.

If you missed the post, you can read it now.

To those readers who took time out of your day to send us your thoughts, thank you. If you’d like to share advice that made you a better investor, email us at [email protected].

Index Summary

• The major market indices moved higher this week. The Dow Jones Industrial Average rose 2.06 percent. The S&P 500 Stock Index gained 2.29 percent, while the Nasdaq Composite rose 2.84 percent. The Russell 2000 small capitalization index increased 2.12 percent this week.
• The Hang Seng Composite rose 2.11 percent; Taiwan fell 1.52 percent while the KOSPI declined 0.16 percent.
• The 10-year Treasury bond yield rose one basis point this week, to 1.72 percent.

Domestic Equity Market

The S&P 500 roared back this week setting new highs and rising by more than 2 percent for the week. The catalyst for the market appeared to be positive economic data out of China and the reassurance that the Federal Reserve’s current quantitative easing (QE) policy will continue.

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Strengths

• The consumer discretion sector was the leader this week as automobile manufacturers, casinos, gaming and internet retailing industry groups were among the best performers. Same store sales data for the retailers were released this week and were generally better than feared due to an unusually cold March. This allowed numerous retail names to rally including L Brands and Ross Stores.
• The healthcare sector was also strong as the biotech names continue an impressive run up. Gilead Sciences, Amgen, Biogen Idec and Celgene Corp. were all very strong performers this week.
• First Solar Inc. rocketed 40 percent and was the best performer in the S&P 500 this week. At the company’s analyst day in New York City, the company raised 2013 earnings guidance as well as estimates for 2014 and 2015.

Weaknesses

• Best Buy reversed course this week, falling over 5 percent, but that was after last week’s roughly 15 percent gain.
• J.C. Penney also fell by more than 5 percent this week as the company ousted its high profile CEO and is attempting to raise as much as $1 billion in financing.
• Newmont Mining was the worst performer in the S&P 500 this week declining 7.6 percent as gold stocks endured a tough week.

Opportunity

• The market is climbing that proverbial wall of worry and just shakes off any bad news.
• Global central banks are literally pulling out all the stops in an attempt to ignite economic growth.

Threat

• A market consolidation wouldn’t be a surprise after a strong start to the year.

The Economy and Bond Market

Treasury yields were little changed this week as global economic data was mixed and stocks rallied. U.S. economic data was generally weaker than expected, while Chinese data was generally better than expected. The University of Michigan Consumer Confidence Index fell to the lowest level since July and is somewhat symptomatic of the economic data of late. As can be seen in the chart, the pattern has been very choppy and more or less moving sideways. So while financial market sentiment improves, we aren’t necessarily seeing that improvement in the data.

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Strengths

• Chinese imports in March rose 14.1 percent, doubling expectations and signaling an improving Chinese economy. Chinese inflation slowed in March to 2.1 percent, which reduces pressure on the central bank to tighten monetary policy.
• Minutes from the Fed’s March 19-20 meeting more or less reiterated its commitment to QE and focus on job growth.
• Inflation data remains benign with import prices and producer prices both falling in March.

• Weaknesses

• Retail sales fell 0.4 percent in March which was well below estimates. Poor weather played a role as it was unseasonably cold in many parts of the country.
• In addition to the University of Michigan Confidence Index mentioned above, the National Federation of Independent Business’s Sentiment Index (small business) also fell in March and hiring plans hit the lowest level in a year.
• Chinese bank loans surged in March, raising inflation concerns and potentially spurring government action to slow growth.

Opportunity

• The Fed continues to remain committed to an extremely accommodative policy.
• Key global central bankers are still in easing mode such as the European Central Bank (ECB), Bank of England and the Bank of Japan. The Bank of Japan in particular is aggressively easing currently.

• Threat

• Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
• Trade and/or currency “wars” cannot be ruled out, which may cause unintended consequences and volatility in the financial markets.

Gold Market

For the week, spot gold closed at $1,483.00, down $98.15 per ounce, or 6.21 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, slid 8.22 percent. The U.S. Trade-Weighted Dollar Index lost 0.45 percent for the week.

Strengths

• An official of the Multi Commodities Centre of Dubai announced gold worth roughly $70 billion was traded through the Emirate during 2012, a more than ten-fold increase from the estimated $6 billion traded in 2003. As the city continues to develop its appeal as a major international gold and precious metals trading destination, the city is planning to develop its local and regional banks into bullion banks, focusing on fulfilling the needs of African producers and satisfying strong demand from Indian consumers. We have spoken to several West African gold producers and they confirm that Middle East investors have contacted them directly to procure gold directly from the company
• Timmins Gold reported preliminary production results for the company’s first quarter ended March 31. The company achieved record gold production of 28,328 ounces for the quarter, representing an increase of 31.6 percent over the same period last year, and beating analyst expectations. Luna Gold also announced first-quarter production this week stating its Aurizona gold mine in Brazil achieved production of 17,203 ounces of gold, beating previous guidance of 15,000 to 16,000 ounces. Needless to say, we are delighted to see management deliver on their expectations.
• The Clinton Group, a hedge fund, continues its attempt to oust the board of Stillwater Mining. The group accused the company of losing more than $900 million during the 12-year tenure of Stillwater CEO Frank McAllister. Furthermore, the group wrote in a letter to shareholders that cash costs have doubled while overhead expenses tripled. The group also states that strategic decisions have been ever worse than the operating performance, leading to the conclusion that the board needs to be replaced. Shareholder activism has yielded some positive results over the last months in the energy sector; we see this as the kick start of shareholder activism in the gold and precious metals space.

Weaknesses

• On Wednesday Barrick Gold confirmed construction on the Chilean side of its Pascua Lama mega-deposit had been suspended as the company attempts to satisfy environmental and regulatory requirements of the Chilean authorities. Production at the mine has already faced several delays, and prior to the suspension, it was expected to come into production in the second half of 2014. The project has also seen multiple cost overruns which have increased the project’s required capex to $8 billion. Barrick’s shares hit a 52-week low the day prior to the announcement and were down 8.36 percent at closing on Wednesday. Foolishly, in their marketing materials, Barrick Gold still states that they will produce gold at $0-to-negative “cash cost” at Pascua Lama. It’s no wonder that Argentina and Chile want a bigger piece of the alleged windfall profits to be had.
• Cyprus has agreed to sell part of its gold reserves in an effort to raise €400 million to help finance part of its bailout. The country holds just under 14 tons of the metal as part of its reserves, and at this week’s average prices, the proposal would mean selling roughly 336,000 ounces, or 9.4 long tons. Although we expect this transaction to be made outside of the market and directly with another government(s), any bid to help out a distressed investor will come at a discount. We suspect Friday’s near 4 percent fall in the price of gold confirmed the trade took place.
• Goldman Sachs’ latest commodities research noted that the negative price action in gold, together with better U.S. economic growth expectations, is leading the firm to close its long gold position. As part of its closing, Goldman Sachs has also lowered its 2013 and 2014 year-end targets for gold to $1,450 and $1,270 per ounce, respectively. Not satisfied, the bank has also initiated a short COMEX gold position. According to some analysts, this may in fact turn out to be the best possible news for the price of gold; if you recall Goldman called for $200 per barrel oil when the barrel was trading at $130 per barrel. We all know it took only six months for oil to crash down to $40 per barrel following this announcement.

Opportunities

• Distrust of the Federal Reserve and concern that U.S. dollars may become worthless are fueling a push in more than a dozen states to recognize gold and silver as legal tender, reports Bloomberg’s Municipal Market commentary. Arizona is set to follow Utah which gave free way for the use of bullion as legal tender in 2011. Similar bills are advancing in Kansas and South Carolina. As per the Federal law, the U.S. Constitution bars state law from coining money or making anything except for gold and silver coin tender for payments. We believe this measure, as well as the number of states currently studying it, is testament to the status of gold as currency rather than commodity.
• At our home in Texas, lawmakers are currently considering a measure supported by Governor Rick Perry to “repatriate” Texas’ gold held in New York in order to establish a Texas bullion depository. Should the state take such a step, it would offer sovereign backing for deposits and make buying and storing gold easier, said Jim Rickards, author of “Currency Wars: The Making of the Next Global Crisis.” This move will reinforce our position that gold could be treated like money, for it is a means of transaction and a store of value, perhaps the best of them all.
• Agnico Eagle Mines of Canada made an announcement this week giving details of its participation in a private placement of 10 percent of Sulliden Gold Corp’s common shares. At this time the size of the deal, relative to Agnico Eagle’s size, may appear small; however, we believe this transaction sets a precedent in major producers recognizing the value proposition of junior explorers and developers at current valuations. We also see a new financing avenue to provide an alternative for cash-starved juniors with good assets. Just when the major equity research houses are telling you to sell gold at its lows and chase the 135 percent run up of the S&P 500 as it sets new all-time highs, senior gold companies are now buying the junior gold developers.

Threats

• An initial review of the President Obama’s proposed federal budget revealed the document proposes an Abandon Mine Lands fee to be levied on metallic mines on both public and private lands. Furthermore, the budget proposal aims to create a leasing process, subject to annual rental payments, and a royalty of no less than five percent of gross proceeds on miners operating on federal lands.
• Behre Dolbear released its latest survey, ranking countries with the best mining investment policies. Somewhat surprisingly the U.S. and Papua New Guinea ranked as the countries with the most numerous permitting delays. What is even more worrisome is that countries like Colombia, which have had numerous lengthy permitting delays in the past few years, is ranked in the top five countries with the fewest delays. The survey certainly shows a very miserable picture of the support the mining industry is currently receiving from the public sector around the world.
• ABN AMRO, the largest Dutch bank by assets, sent a letter to its clients this week stating that it had no physical gold available for delivery. Instead, the bank is offering customers a monetary claim at the current market rate for gold. The result is that instead of owning a risk free, physical asset (gold), the bank’s clients now own a monetary claim on ABN AMRO, and are exposed to the bank's credit risk. The key takeaway from this move is that insiders now know that the true value of gold is much higher than that of the market and that it has to be protected at any cost, even at the expense of loyal customers.

Energy and Natural Resources Market

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Strengths

• Natural gas futures (NYMEX) closed the week at another 52-week high of 4.23 per mmbtu.
• Imports of liquefied natural gas by Japan’s 10 major power utilities in the fiscal year ended March rose to 58.3 million tons from 55.5 million tons in the prior year, the Federation of Electric Power Companies said.
• Chinese car sales continue to boom, rising 15 percent year-over-year in March to 1.46 million vehicles, according to data released by the Chinese Passenger Car Association (CPCA). Over the first quarter they totaled 4.2 million, 19 percent higher year-over-year. This is potentially good news for palladium, as nearly one-sixth of total demand was from Chinese autos in 2012.

Weaknesses

• Bloomberg reported that coal miner Xstrata will sell thermal coal to Tohoku Electric Power at $95 per ton, the lowest settlement price since 2009.
• Three high-profile benchmark forecasters have lowered their global oil demand growth forecasts reflecting a more bearish tone to the outlook for this year. The U.S. Energy Department and the Energy Information Administration trimmed their 2013 growth forecast by 50 thousand barrels per day and now see oil demand growth at 960 thousand barrels per day this year. OPEC cut its 2013 forecast by 40 thousand barrels per day and now expects global oil demand to rise by just 800 thousand barrels per day this year. The International Energy Association cut its estimate by 45,000 barrels a day, predicting that world consumption will increase by a “subdued” 795,000 barrels a day, or 0.9 percent, to 90.58 million barrels a day this year.

Opportunities

• The Potential Gas Committee released its annual report this week and suggested that potential U.S. natural gas reserves are 2,354 trillion cubic feet (TCF) up by 486 TCF from last year. This is additional to the proven reserves of 305 TCF. The increase is attributed to a reassessment of the potential of the Marcellus and Utica shale plays. This group is funded in part by the exploration and production companies and the Wall Street Journal suggests that this new study will help lawmakers with decisions on U.S. gas exports.
• The high cost of energy in Chile is threatening the competitiveness of the country's copper industry and poses a major challenge for new development, industry executives at a copper convention in the Andean nation said this week. Electricity costs in Chile, the world's top copper producer, have risen 11 percent per year since 2000, making it one of the most expensive places in the world to secure energy for mining projects. With regulatory gaps making it difficult to permit new power infrastructure, the situation could get critical, according to Diego Hernandez, chief executive of Antofagasta Plc. "I think Chile can continue to have a huge advantage in mining," he said. "We have the deposits, but if we don't solve, among other things, the fundamental issue of making energy happen at a competitive price, it's not going to succeed."

Threats

• BHP Billiton Ltd., the world’s biggest mining company, said Australia’s mining industry needs a new plan as the sector battles costs that are rising faster than its global competitors. “When we talk about capturing the next generation of opportunities in the resources industry, we need a new plan – a plan with national productivity at its core,” Jac Nasser, chairman of the Melbourne-based company, said today in notes for a speech to the Australian British Chamber of Commerce. “The industry has experienced unprecedented growth. At the same time Australia’s costs rose more quickly than our global competitors.” BHP paid $9 billion in taxes and royalties in Australia last year, out of a global total of $11 billion, Nasser said. The company had 52 percent of its long-term assets located in Australia as of the year ended June 30, 2012. “This is an effective tax rate in Australia of 45 percent,” he said.
• Inventories of steel products in China hit a record high in March, the Ministry of Industry and Information Technology (MIIT) revealed, in further bad news for the nation's steel sector, which has been hit hard amid the economic showdown. The total stockpiles of five major steel products across 22 cities reached a new record of 15.57 million tons during March, up 22.9 percent compared to a month earlier, the ministry said in a statement on its website, citing the latest figures from the China Iron and Steel Association (CISA).

Emerging Markets

Strengths

• China’s March CPI was 2.1 percent year-over-year falling short of market expectations for 2.5 percent. The benign inflation number will allow China’s central bank, People’s Bank of China (PBOC), to stay on neutral monetary policy to support the government’s growth objective. PPI was down 1.9 percent, proving weaker industrial demand, further limiting the central bank’s ability to tighten the money supply.
• In March, China’s new bank loans were Rmb 1.06 trillion versus market expectation for Rmb 900 billion; and M2 money supply grew 15.7 percent versus market expectations for 14.6 percent. Total social financing grew Rmb 2.54 trillion versus the estimated increase of Rmb 1.81 trillion. Those money supply statistics showed a strong demand for credit and good liquidity in the system.
• China’s March passenger vehicle sales increased 17 percent year-over-year to 1.39 million units, showing robust consumption growth.
• H share stocks are traded at 8.75 times forward earning with 3.5 percent dividends yield, the cheapest valuation and highest yield among the markets in China’s neighboring countries.
• Mexico released very encouraging gross fixed investment numbers for the month of January. According to the National Institute of Statistics, gross asset fixed investment increased at a pace of 4.6 percent from last year, beating analysts’ expectations by 100 basis points. The greatest expanding subcategory was machinery and equipment which bodes well for bullishness in the construction sector for the remainder of the year.

Weaknesses

• China’s March exports grew 10 percent year-over-year, lower than consensus of 11.7 percent, while imports rose 14.1 percent, higher than market consensus of 6 percent, resulting in a trade deficit of $884 million. Nevertheless, both export and import growth accelerated for the first quarter, with exports up 18.4 percent and imports up 8.4 percent, logging in a trade surplus of $43.07 billion versus $220 million in the same period last year.
• Fitch ratings downgraded China’s long-term local currency IDR rating to “A+” from “AA-“, with a stable outlook. Fitch cited five reasons for the downgrade, including fast credit expansion, proliferation of shadow banking, local government debt, lower fiscal revenue base versus other A-rated peers, and less track record on inflation management versus same peers. Investors in Hong Kong and China had largely ignored the downgrading event since those reasons are debatable.
• The Philippines’ February exports dropped by 15.6 percent versus the consensus decrease of 4.8 percent, which saw broad-based external demand weakness.
• The Monetary Policy Committee (MPC) of the Bank of Korea (BOK) kept its policy rate on hold at 2.75 percent, while the market had expected a rate cut by 25 basis points. The MPC, however, increased a policy lending window earmarked for small and medium sized companies from 9 trillion won to 12 trillion won and cut its base rate from 1.25 percent to as much as 0.5 percent. BOK also lowered its 2013 GDP growth forecast to 2.6 percent from 2.8 percent released in January, but the market expects an upside from the lowered forecast.
• Malaysia saw its February industrial production fall 4.5 percent below the consensus decrease of 2.5 percent, mostly due to shortened working days during Chinese New Year holiday.
• Bank Indonesia, the central bank, kept its policy rate unchanged at 5.75 percent, but lowered GDP forecast to 6.2 – 6.6 percent from the previous range of 6.3 -6.8 percent. The risk is fuel price measures, which can inflate consumer goods prices if subsidies are removed.
• Brazilian news continues to show deterioration in the overall economic environment. Just this week the balance of trade started showing signs of declining exports on the back of sluggish global economic growth. The decline in inflation for the month of March relative to February was not enough to prevent the CPI to breach the annualized 6.5 percent tolerance threshold, and UBS reported it estimates first quarter GDP growth to disappoint by growing roughly at half the pace of its already conservative 1.4 percent original estimates.

Opportunities

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• As shown in the graph, the internet sector outperformed during the SARS period in 2003. After the SARS pandemic, the overall market rebounded and ended the year much higher. The current bird flu outbreak seemed well under control in the last couple of weeks, and social order in China is as normal as before.
• This Sunday, April 14, will mark the first time in 20 years that a presidential election in Venezuela will not have Hugo Chavez as a candidate. The consensus among local political analysts is that interim President Nicolas Maduro will win the elections by campaigning on Chavez’s platform. Despite the fact that the majority of the polls show Maduro will outvote opposition leader Henrique Capriles by a comfortable margin, we believe there is an opportunity for the opposition to narrow the 11-point gap of last year’s elections. A narrower win by the “chavismo” could lead to Maduro softening his party’s critical and debasing stance towards the opposition.
• Odds on Macau gaming revenue are rising as credit rating service Fitch raised its outlook, the latest in a string of upbeat reports on the Chinese gambling enclave. Fitch now expects Macau gambling revenue to rise 11.5 percent in 2013, up from its prior 8 percent forecast. Macau officials recently said gambling revenue jumped 25 percent in March, to nearly $4 billion, a new monthly record.

Threats

• For China, monetary policy directions are determined by inflation expectation and economic growth maintenance. Presently, neither of the two factors seems to cause any policy threat on the equity market, but other risk management measures in financial market, such as wealth management product regulations, could cause some short-term market volatility.
• Bank Indonesia may raise its benchmark some time over the year since CPI is threatened by trade deficit.
• The Peruvian government continues to do “whatever it takes” to tame a potential appreciation of its currency, the New Sol. This week, and for the third consecutive time this year, the central bank allowed an increase in pension funds’ cap on foreign investment. The measure, now at 36 percent after the last lift, is far above the 10.5 percent of 2006. While we welcome the move to allow greater investment flexibility, the estimated $1.7 billion of potential outflows estimated by Deutsche Bank could pose a threat to the already underperforming Peruvian stock market, and to the rallying local corporate bond market.

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