The debate continues to rage over the short term as to the direction of copper prices.
- The bears say that demand in China is slowing and that supplies are plentiful…
- Meanwhile, the bulls point to steady demand from China. They also point to those in the industry who say that supplies are dwindling due to a lack of big discoveries and the lower quality of the ore being mined today from all parts of the globe.
Bottom line: For the short-term the supply/demand equation for copper looks uncertain.
Over the longer term, however, the direction definitely looks to be positive for the bulls.
Demand for copper from the emerging world, as it builds out its infrastructure, will more than offset any slackening of demand from the developed world.
In addition, there’s no denying the lack of major copper finds, over the past several years, and the lower quality of the ore being mined today.
And now, copper bulls have another factor in their corner… geopolitics.
Peru’s importance to the global copper market
Mention copper-mining countries to most investors, and Chile quickly springs to mind. That South American nation is the world’s number one producer of the red metal, accounting for about one-third of global copper supplies.
But most investors are unaware of the importance of Chile’s neighbor – Peru – to the global copper market. It’s already the world’s second-largest copper producer, roughly equal to the United States and ahead of China and Indonesia.
Over the next five years, that country’s importance is poised to grow on the back of a string of expansion plans and new projects. This growth will be led by projects from companies such as Freeport McMoRan (NYSE: FCX, Stock Forum), Anglo American and Xstrata.
In fact, Macquarie Bank from Australia estimates that Peru will account for a hefty 32 percent of global mine output growth over the next five years.
With global supply and demand for copper in a delicate balance, supplies from these Peruvian projects will have a huge impact on the direction of copper prices.
This is where geopolitics enters the picture…
Peru elects new President and geopolitics enters the fray…
Peru has just elected a new president, Ollanta Humala. He’s a former army officer who attempted a coup in 2000. Mr. Humala once espoused hard-left and nationalist views and was close to Venezuela’s president, Hugo Chavez.
During the campaign, he promised to raise taxes on the mining sector. He suggested that Peru could impose a windfall tax of up to 40 percent and also raise the corporate rate that miners pay to 45 percent. It’s currently 30 percent. Mining companies also pay a three percent royalty tax and other duties.
If Mr. Humala does raise taxes, some projects are at risk.
Projects for the few years up to 2014 appear safe. Mining companies have so-called stability agreements that protect them from any tax increases. But many of these agreements, negotiated in the 1990s, will expire over the next few years.
So expansion plans and new mines for years after 2014 – when Peru is expected to account for more than two-thirds of the global increase in copper mine output – would certainly suffer.
This would certainly push the supply/demand equation strongly in favor of the bulls.
Michael Bogusz, a mining analyst at Macquarie, put it this way: “We believe that investment in new mines may be delayed and marginal projects may even be canceled. As a result, any delay in investment decisions will further tighten the supply side.”
Humala models Peru’s governance after Lula’s Brazil
Mr. Humala insists though that his model for governance is not Hugo Chavez, but Brazil’s former president Lula.
Lula was also a leftist candidate. But he demonstrated it was possible to combine a business-friendly economic policy with social reforms that reduced poverty.
The path that President-elect Humala chooses – Lula or Chavez – may well determine Peru’s future.
And it will certainly help determine the future course of copper prices. If he chooses Chavez instead of Lula, look for much, much higher copper prices several years down the road.