Dr Copper makes a comeback

High-yielding equities are not the only asset class attracting investors as funds are rotated out of bonds and other “safe” havens.

The bellwether of commodities, Dr Copper, has been moving steadily higher over the past six months thanks to strengthening Chinese demand.

Since early August last year the price of copper has risen by 11% from $US3.29 a pound to $US3.66/lb, with the rise attracting the first flush of money into exchange-traded copper funds.

Last week the specialist fund manager, ETF Securities, reported an inflow of $US28 million into its ETFS Physical Copper product, the biggest inflow since it was launched in 2010.

Of equal interest, the copper sector has just seen the launch of its first big takeover for some time with Canada’s First Quantum offering $US5.1 billion for Inmet, a company with a big undeveloped copper resource in Panama.

Not all Australian copper stocks are reacting positively to the rising price of the metal and its return as a yardstick for global economic health. It is also a useful pointer to business activity in China, which consumes an estimated 50% of the world’s copper in a vast array of applications from construction to electronics.

Some producers have greeted the copper price rise with falling share prices, an indication that the recovery of interest in commodities is being tempered with a close eye on profitability and the growth prospects of particular stocks.

The performance of three local copper leaders reveals a mixed picture, and serves as a possible guide to the best capital gains in the next phase of the copper revival coming from the emerging producers and companies yet to reflect the more positive outlook for the global economy – and stronger copper demand.

Before exploring for hidden value in the next generation of miners, here’s a look at what’s happened to the current generation.

• OZ Minerals (OZL), a copper producer popular with some investors, has fallen by 12% even as the copper price has risen by 11%, slipping from around $7.70 to recent trades at $6.74. The problem for OZ is that its primary asset, the Prominent Hill mine in South Australia, is getting deeper and becoming more expensive while new projects, such as the Carapateena project, will not be in production for several years.
• Sandfire (SFR), another local favourite and possible takeover target for OZ, has done better over the same time, rising by 12% from $7.05 to recent trades around $7.91. But it has also suffered a recent sell-off from the peak of $9.09 reached on January 3. The problem for Sandfire is that it has encountered processing problems in the early months of its new Doolgunna mine in WA, and is yet to make a second discovery, leaving it as a “one-trick pony” that will generate plenty of cash but not the growth option investors seek.
• PanAust (PNA) has performed well over the past six months, rising by 21% from around $2.44 to S2.96, but it was doing much better up to early January when it touched $3.51. The recent sell-off followed a quarterly report which was solid but below analyst expectations.

OZ, Sandfire and PanAust all fall, rightly or wrongly, into a category marked “mature miner” with appeal to investors looking for steady earnings.

But, they are also examples of why, in the investment world, it is often better to travel than to arrive.

In the travelling category, there are four emerging copper stocks worth a close look that are yet to receive the uplift which comes from the transition from explorer to producer. They are:

• Rex Minerals (RXM), a stock sitting on what is claimed to be Australia’s biggest undeveloped copper orebody, but with the challenge of raising the best part of $1 billion to convert its discovery into a mine.
• Hot Chili (HCH), one of the Australian copper explorers active in the world’s best copper address, the Andes mountains of Chile.
• Blackthorn Resources (BTR), which has started a pre-feasibility study into its high-grade Kitumba discovery in Zambia. The discovery sits inside the bigger Mumbwa prospect that once attracted BHP Billiton for its potential to be a world-class mine.
• Marengo Mining (MMC), a frustrating stock for many investors because of what seems to have been slow progress at its big Yandera project in Papua New Guinea. But it has the appeal of an imminent decision to proceed, backed by a Chinese construction and copper-buying partner, and a recent shift of domicile to Canada, which will bring in North American investors.

Of those four copper stocks awaiting the uplift of discovery by investors, the two most likely to be re-rated over the next few months are Rex and Hot Chili.

Rex, because it will either successfully raise the debt and equity required to develop its Hillside project on South Australia’s Yorke Peninsula, or it will be acquired by a bigger company with the power to fund the development.

Hot Chili, because it continues to expand the size of its Productora copper discovery in Chile and will either move towards development, or face the same issue as Rex – a takeover bid from a bigger company that can take the project to development.

It is the “development or takeover” options which make Rex and Hot Chili worth watching. Either they start mining their discoveries or they become easy acquisitions.

A step in that profile-raising direction will be taken by Rex next Thursday at the Sydney Mining Club. That’s when the company’s recently appointed chief executive, Mark Parry, will launch a marketing campaign aimed at convincing investors that Rex can raise the capital to develop a mine capable of producing 100,000 tonnes a year of copper equivalent (70,000 tonnes of copper itself, plus by-product credits in the form of gold and iron ore).

Hillside’s pre-feasibility study released in late October points to a mine yielding copper at a cash cost of around $US1.20/lb, comfortably below the current copper price with the margin pointing to potential future annual operating cash flow of $240 million a year.

But if Hillside looks good on paper, it begs the question as to why Rex looks so cheap at its latest price of 67c, which values the company at a lowly $127 million.

The answer to the low price is almost certainly the challenge of a small company raising at least $900 million to fund the mine’s development in a market where risk capital is getting easier to find, but nowhere near as easy as it was five years ago.

Parry might have more to say about funding options next week, but whether he has a plan (or not) the copper in Hillside is waiting to be developed by someone.

Hot Chili is less well advanced than Rex but it has been attracting more investors, with the stock last week trading up to a 12-month high of 81c. It has slipped back this week to around 78.5c, a price which values the stock at $231 million. This is $104 million more than Rex, with a project that might one day be bigger but which is still in the exploratory drilling phase.

Unlike Rex, which is yet to attract a potential takeover suitor, Hot Chili looks to be ready for corporate action. The Canadian-based Lundin Mining emerged late last year with a 5% stake in the stock, and Hot Chili is expected to soon announce a significant resource upgrade at Productora.

Another investor on the Hot Chili share register keen to take profits from corporate activity rather than hang around for dividends is Taurus, a boutique funds manager with a successful track record in picking winners.

All of the emerging miners, Rex, Hot Chili, Blackthorn and Marengo, have one factor working in their favour, Dr Copper himself. And while no-one is tipping a rush by the price of the metal back over $US4/lb, there is undoubtedly a rising trend which directly reflects improving Chinese industrial production.