Copper supply is expected to exceed demand by a substantial margin in 2014, threatening the outlook for an already-beaten-up Canadian mining sector.
The median analyst estimates for global copper supply and demand suggest an oversupply of 408,000 metric tons for 2014. This would be the largest surplus since 2001, a year when the copper price fell 19.4 per cent.
Supply, not demand, is the problem. Bloomberg News reports that "producers from Rio Tinto Group to BHP Billiton Ltd. added 3.4 million tons to output since 2003, about what Europe uses in a year, and Morgan Stanley expects another 4.1 million tons by 2017."
Copper prices have been stronger of late, after Chinese economic data indicated another ramping up in construction activity. The expected supply overhang, however, implies that the price gains will be short-lived.
Credit Suisse commodity research strategist Andrew Shaw was among the first to sound the alarm on excess copper production in 2012, and remains cautious: "We have not altered our structural medium-term view of slower demand growth meeting stronger supply growth." Mr. Shaw expects a 20.4 per cent decline to $2.63 (U.S.) in the copper price between now and the end of 2014.
It's no surprise that Canadian mining stocks are heavily influenced by changes in the commodity price. The chart illustrates the extremely high correlation between the two (a coefficient of 0.92) during the past three years.
Canadian mining stocks have already been hit hard and are now at valuation levels well below their historical averages. Forward price to cash flow multiples have fallen from a recent peak of 12 times in 2010 to the current 7.5 times. This should help protect stock prices to some extent.
Even so, the chart implies that a move lower to $2.63 for the copper price is likely to drag the mining sector with it. Within the TSX Capped Diversified Metals and Mining index, the stocks that seem most vulnerable are HudBay Minerals Inc., currently trading at 17.5 times forward cash flow estimates (though it does have a huge hoard of cash on the balance sheet), Lundin Mining Corp. (8.5 times) and First Quantum Minerals Ltd. .
Scott Barlow is a contributor to Globe Unlimited. Click here to read more of his work, and follow Scott on Twitter at @SBarlow_ROB.
Scott Barlow