Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Is the red metal finally in the black?

Three-month copper futures on the London Metal Exchange are up more than 3 percent over the past four trading days, heading toward their longest rising streak since October. Hedge funds' net short position in Chicago copper futures shrank last week to the lowest level since November, suggesting they're getting more nervous about betting prices are going to fall.

Volatile Metal
Hedge funds' net short position in Comex copper futures has been narrowing
Source: Bloomberg data

You can ignore all that stuff, though. Market prices and positions gyrate from week to week. If you really want to know where things are going, look at the prices that copper producers and traders are prepared to pay for long-term access to ore.

Sumitomo Metal on Monday paid Freeport-McMoRan $1 billion for a 13 percent stake in Morenci, a pit in Arizona that produces about 900 million pounds of copper a year. Spread over a 10-year investment horizon, it's getting its hands on about 1.17 billion pounds of metal for about 85 cents a pound.

That sounds like a fire-sale price -- after all, Comex futures are trading at about $2.08 a pound right now. But consider that Sumitomo will also be shouldering its share of operating costs (Freeport's North American mines made a profit of just 10 cents a pound in the December quarter) and look at it in the context of recent comparable deals, and it starts to look like a glimmer of hope for a metal which fell 41 percent over the past three calendar years.

Mining takeovers are ultimately about buying access to a stream of cash. To work out how much, companies do a bit of educated guesswork about the amount of ore a pit can produce and the sort of margin it can earn on each ton. One very rough-and-ready way of working this out is to look at how the price paid compares to the amount of metal the mine can be expected to produce over a decade.

Turning Copper
The price that buyers are prepared to pay for 10 years of metal production may be recovering
Source: Company reports
Note: Equinox/Barrick and Inmet/First Quantum were takeover deals; OZ Minerals/KKR was a share purchase; all other deals were inter-company sales of assets or asset stakes. 10-year production volumes have been estimated based on published mine plans where available, production forecasts, or trailing 12-month output

Go back to 2011, when Comex copper was trading well over $4 a pound, and you see prices that would now make an investment committee blench. Barrick Gold and Mitsubishi both paid more than the current market price for the right to shoulder a load of processing costs as mine owners. 

Transaction values have since fallen. Lundin Mining paid about 59 cents a pound in 2014 for its 80 percent stake in Candelaria and Ojos del Salado, two Chilean mines put up for sale by Freeport. KKR picked up a 10 percent stake in OZ Minerals for even less last November, paying just 30 cents a pound based on the 114,000 metric ton-per-year forecast output of the target's Carrapateena project.

Against that backdrop, the 85 cents a pound that Sumitomo is paying for Morenci looks rather attractive. It's in line with what MMG paid Glencore for its Las Bambas project in 2014, and what China Molybdenum gave to Rio Tinto for its share of Australia's Northparkes mine the previous year. 

The usual caveats apply. Japanese trading houses don't have a reputation for driving hard bargains for their stakes in mines. They often seem more concerned about their long-term supplies of raw materials than whether investments cover their cost of capital. The transaction also helps to reduce Freeport's $20 billion debt pile, which has been downgraded to junk by both Moody's and Standard and Poor's within the past month. Sumitomo is a phenomenally patient investor -- it acquired its original 15 percent stake in Morenci from Phelps Dodge in 1986 -- so has an interest in ensuring the ongoing financial health of its partner.

The price should nonetheless stiffen the spines of potential sellers at a time when many analysts are urging the better-capitalized miners to pick up assets at rock-bottom prices. In the M&A market at least, copper may have found a bottom.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net