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The cases for gold and copper versus iron ore

Savvy investors should look to gold and copper for superior returns, according to InvestSMART’s Tony Kaye.

Copper and gold have two very different markets, but for an investor concerned about the uncertain economic outlook they are a perfect combination.

Copper for good times, and gold as an insurance policy against bad times.

Nature seems to have figured this out long before people started beating copper into pots and pans, or adorning themselves with gold trinkets. The two metals often occur in the same orebodies, which means some mining companies are ready for whatever comes next.

OZ Minerals and Sandfire Resources are examples of locally-listed miners working orebodies rich in both copper and gold, with their respective share-price rises of 23.5 per cent and 16.7 per cent since the start of the year a reason for refreshing interest in both metals (and both companies).

What makes the copper and gold situation quite interesting today is that while both are enjoying strong price support, albeit for different reasons, they are also metals which suit big and small companies.

BHP and Rio Tinto, while currently dominated by their iron ore interests (and oil in the case of BHP), have both elevated copper to the top of their targets for exploration and future project-development.

Gold is a newsmaker today for a different reason. Its rising price, and a high level of economic and political uncertainty, means that gold’s dual roles as a commodity and currency has unleashed a fresh round of takeover activity.

Canadian-based Barrick Gold has just made a hostile $US18 billion takeover bid for Newmont Mining, which could result in the sale of their Kalgoorlie super pit joint-venture.

Barrick has already recently taken over African-based Randgold Resources, and Newmont has also already announced a $US10 billion merger with Canada's Goldcorp to create the world's biggest gold stock. This rush to deals is highly likely to spill over into Australian gold stocks, either as targets or as the acquirers of surplus assets spun free from the mega-mergers.

Small and mid-tier Australian gold stocks are likely to get sucked into an outbreak of merger mania with the best opportunities coming from a policy of buy the target and sell the bidder, because a lesson from past takeover sprees is that they destroy more value than they create.

Iron ore and coal

The return of copper and gold to the top of the mining sector means that iron ore, the leader for the past 20 years, is fading. But it’s not disappearing, as a recent price surge demonstrated when Brazil was forced to cut output after a series of deadly mine site accidents involving the collapse of tailings (mine residue) dams.

The iron ore bounce should prove to be short-lived as Brazilian production recovers and is delivered into an already well-supplied market. The biggest producers (BHP, Rio Tinto and Fortescue) will do well, but small miners will continue to struggle unless they have access to super high-grade ore of the sort being mined by Mt Gibson Iron on Koolan Island.

The other Australian bulk commodity specialty, coal, faces well-reported headwinds, and while companies in production will generate strong profits simply because starting new mines has become exponentially harder, the risk factors are rising with metallurgical coal used to make steel an exception.

If iron ore and coal are seen as yesterday’s preferred minerals, the future belongs to a different group that includes the battery-metals family (lithium, cobalt, nickel and graphite to name four) and copper, which is the world’s most widely used industrial metal, and gold, which is the go-to metal for troubled times.

Copper charge

BHP and Rio Tinto are already two of the world’s biggest copper producers and they want more, thanks to a widespread view that a copper shortage is developing with the price poised to move back above $US3 a pound and stay there for some time.

Both big miners are doing more than milking their existing copper mines, with exploration starting to yield hints of major discoveries; BHP at a prospect close to its Olympic Dam mine in South Australia and Rio Tinto in the remote Paterson Range of WA.

Gold spike

Gold, which is not a primary target of BHP or Rio Tinto, is nevertheless a handy by-product from copper mining for both companies, and a significant profit driver for pure-play gold producers which are riding the economic uncertainty factor.

Local leaders, such as Newcrest, Evolution, Northern Star and St Barbara, are benefiting from the gold price moving up to around $US1325 an ounce over the past six months and the more impressive move into all-time record high territory for the Australian gold price, which at $A1850/oz is benefiting from the underlying US price and a weaker Aussie dollar.

For investors with an interest in mining, right now is a time to reflect on an old adage from the race track when a punter was uncertain about a particular horse which led to placing “two-bob each way” – one bob (yesterday’s slang for a shilling) for a win and one bob for a place.

If iron ore and coal are fading as growth sectors, then copper and gold are moving to the top, which is the way some of the world’s top investment analysts see things.

The case for gold, admittedly a commodity difficult to understand, is best demonstrated by its role as a currency beyond the paper-printing activities of governments and as a last-resort store of value – which is why the world’s central banks are buying gold at the fastest rate in 50 years.

Two of the biggest gold buyers are Russia and China, with their motivation appearing to be a desire to limit exposure to the US dollar, either because of political disagreements or because Russian and Chinese bankers (along with many in Europe) reckon the US dollar is poised for a big fall caused by excess paper-money creation in the years since the global financial crisis. In simple terms, if the dollar falls gold rises.

Whether an investor understands gold is not the point because the reality of gold is that governments trust it, in many cases more so than they trust their own currencies, and certainly more than someone else’s currency.

Supply deficit

Copper is much easier to understand because it really is a metal driven by the forces of supply and demand, and right now demand growth might be modest as global manufacturing slows, but supply growth is even slower.

Looking forward, the world needs a major increase in copper production to meet ongoing demand in the construction and electronics industries and from the big new copper-consumer, electric cars, which used three-times as much copper as a conventional car.

Morgan Stanley, an investment bank, said earlier this month in a major study of the copper sector that “the stars were aligning”, with a copper-supply deficit emerging this year as mine production has slowed (ageing mines) and demand growth is ticking over at an annualised 2 per cent.

“That should lift prices to $US3.09/lb in 2019 before a return to balance leads us to expect a continued trend towards our long forecast of $US2.80/lb, or $US3.19 nominal in 2015,” Morgan Stanley said.

Copper started 2019 at $US2.65/lb and is currently trading at $US2.96/lb, its highest since last June.

Citi, another investment bank, has been arguing for some time that copper is poised for a price rally as investors pay more attention to the metal.

What caught Citi’s attention was a sharp fall in global copper stockpiles to a 10-year low and surprisingly strong demand growth in China despite the pressure from the trade war being waged with the US.

A local bank, ANZ, weighed into the copper case this week with a report which noted the strong fundamentals of copper that include the unexpected Chinese demand rebound and supply disruptions which should see the market remain tight throughout 2019.

“We have a three-month price target of $US6750 a tonne ($US3.06/lb), with prices likely to extend to $US7000/t ($US3.18/lb) in the second half of 2019.” ANZ said.

Perhaps the key point for investors is to recognise that bulk commodities (such as iron ore and coal) have peaked in the current cycle with solid supply meeting weak demand growth whereas copper and gold (and the battery metals) are on what should be sustained upward price moves.

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