A commodity upcycle is plausible to probable over the next decade. Here I share my research seeking to understand a specific mining company, Copper Mountain Mining Corporation (TSX:CMMC:CA ). An investment in CMMC would complement my established investing in oil and gas companies.
The present article is my first coverage of mining. It explores a lot of ground as a result. I welcome corrections from those more knowledgeable.
The article takes up the following topics in turn.
This all leads to a longer than normal article. I hope it may serve others who like me are new to mining investment.
Many investors will seemingly buy resource extraction companies in any country. Well that's an exaggeration; nobody seems to be buying Venezuela, for instance.
I am more concerned than many of them are with the political stability of much of the world. It seems to me that many South American countries dabble regularly with politicians who would happily nationalize their mines, or tax them excessively if not. And while Africa has made great strides economically and politically, it does not seem to me that one can count on stability there either.
This leads me to favor North America, Australia, and perhaps Europe. It is notable, though, that "environmental" protests recently led Serbia to cancel plans for a lithium mine to be developed by mining giant Rio Tinto (RIO).
The Serbian example is a snapshot of one thing among many that will prevent an energy transition on any timescale like those promulgated by the green-media-political complex. It will be politically difficult to bring major mining developments to regions that do not have a long history with them.
In addition to that, my strong preference is to find a pure-play copper producer, or one close to that. The majors like RIO and BHP Group (BHP) produce large quantities of coal and/or iron ore, in addition to copper.
Coal (leaving aside types of coal) is having a great year, but the long-term case for coal demand is fuzzy at best. And iron ore demand is dominated by China even more than other commodities, because of the massive amounts of construction they do.
Ultimately, though, each commodity is subject to its own vagaries of supply and demand. If you want to focus on one of them, the majors may not be for you.
It is informative to compare the price of two majors with the copper pure-play that is my subject here. CMMC has dropped far more than RIO, BHP [and also Freeport-McMoRan (FCX)] since last September.
If you date the comparison from November, the disparity is larger. Ivanhoe (OTCQX:IVPAF), which is a copper pure play, has dropped about as much as RIO. They are much larger than CMMC but not yet cash-flow positive. The price trend of CMMC looks qualitatively like the recent trend for copper from macrotrends:
But while copper has dropped 25%, CMMC has dropped 55%. Beyond that, CMMC is down 64% from its May 2021 high.
Perhaps CMMC was overvalued relative to its prospects over its mine life. Perhaps those prospects have recently changed. Perhaps the stock has dropped so far that it is now undervalued.
A fellow member on EIA introduced me to CMMC last year. I made some pretty big gains from the rapid price increase in October, then sold. That also was just before I changed my approach to one of holding larger positions that receive more scrutiny.
Copper Mountain is a pure-play copper miner (of course, they also sell the gold and silver that comes along with the copper). They are small - they have only one operating mine, in Canada. They also have developmental property in Australia.
The mine is situated 20 km south of Princeton, British Columbia and 300 km east of the Port of Vancouver. Production of copper concentrate commenced during the third quarter of 2011. The property covers an area 67 square kilometres, making it not atypical for a large copper mine.
Quoting the Q2 2022 MD&A:
The mine is a conventional open pit, truck, and shovel operation. The mill consists of one SAG mill, three ball mills, a rougher flotation circuit, regrind mill, a cleaner flotation circuit, a concentrate thickener, and a pressure filter. The mill throughput is approximately 16.4 million tonnes per year. Copper concentrate from the mine is trucked to the Port of Vancouver where it is placed in a storage shed for loading onto ocean-going vessels for transportation to Japan.
Here is an overview of their property in Canada:
Mining to date has been in the Main Pit, with the first mining of the North Pit just starting. New Ingerbelle has seen a lot of exploratory drilling in recent years, with positive results for the future.
Looking through their materials, it seemed notable to me how dynamic the mining locations were. Here is 2017:
Mining any specific location involves stripping material above the quality ore, mining the quality ore, mining out some lower-quality ore below it, and moving on. The process seems to take about two years per location, so the area being mined moves around fairly rapidly.
The description above identified the mills and other components of the processing equipment at the mine. Except for the ball mills, they have one each.
What's more, the ore processing involves using most or all of those components in sequence. In other words, they represent a linked chain of potential single-point failures. When something fails, production drops until they get it fixed.
I grew up amidst old mine pits in the Colorado mountains, but never was directly involved in mining. My professional experience did include big projects and gigantic hardware, though.
A mine is simple, but the simple is indeed hard. You mine boulders of ore and then crush them into small particles. You practice comminution - the action of reducing an ore to minute particles or fragments. You then use chemical and/or fluid-dynamic magic to extract the metals you want.
The mining itself, in an open-pit mine like Copper Mountain, produces far more waste than ore. Here is the history since 2014:
The mine has a capacity to mill ore, relatively fixed. This is why the tonnes milled is relatively constant. The right scale shows ktpd (kilo tonnes per day).
As the yield of ore worth milling varies, one has to mine a smaller or larger volume. This is why the tonnes mined varies relative to those milled.
Handling these huge volumes of ore takes huge hardware, hard to fix when it breaks. Here is the lower main frame of the secondary crusher at CMMC, being installed in 2013. Note the size of the people.
I'm an operations guy and love this stuff. That crusher has to work; keep the finance guys away.
CMMC formed in 2006 to purchase a defunct copper mine and exploit the vast deposits believed to exist there. This let them get going in record time, leading to an IPO in 2011.
The initial vision laid out in the Q4 2011 MD&A was this:
The development plan was based on combining the three existing pits into one larger super pit and constructing a new 35,000 TPD concentrator designed to produce approximately 100 million pounds of copper per year in a copper concentrate.
This proved optimistic. If you get 90% recovery of ore with a 0.4% feed grade (concentration of copper), then 35 ktpd gets you 100M lbs per year of copper.
In practice, Copper Mountain has managed near 80% recovery, not 90%. Their concentration also has fallen short of 0.4%, as you can see here:
The low year in 2022 just represents some bad luck as they worked their way out of one location and into another. The Feed Grade will run comfortably above 0.3% on average going forward. In contrast, 2021 was a really lucky year. That will not repeat often either.
On top of that, getting to or above 35 ktpd of milling proved challenging. Making progress there led to a fascinating paper. It was published by the Coalition for Eco Efficient Comminution (love that name!). Quoting:
Copper Mountain's concentrator was commissioned in May 2011. … From startup, the mill struggled to meet the required production rates. Over time, a major initiative that involved blasting and fragmentation, optimization of the SAG mill in terms of discharge grates, ball size and slurry density, and operation of up to three mobile pre-crushing plants resulted in significant increases in throughput.
Reading snippets shared in earnings calls, this is the process. Upgrade hardware to increase capacity. Then fix and/or upgrade whatever else can't keep up with the higher rate, and whatever breaks. Rinse and repeat.
CMMC pushed nominal capacity up to 40 ktpd, which they hit only once, in 2019. Now they are targeting 45 ktpd, which is the aim of the current cycle of upgrades.
CMMC also has often targeted production of 90M to 100M pounds of copper in a year. They only hit that once, in 2021, when they happened to be mining particularly rich ore.
At 45 ktpd and 80% recovery, CMMC can exceed 90M tonnes with a copper concentration of 0.32% in the ore. They are clearly pushing for this, and it looks feasible, but it is hard to judge what will be the time needed to work through all the necessary upgrades.
CMMC just finished adding a third ball mill in support of 45 ktpd. It is now working as intended.
Here are examples from the Q2 2022 earnings presentation of current projects supporting higher throughput:
All this activity costs money, of course. CMMC evaluates the All In Sustaining Costs, or AISC. AISC "seeks to present a full cost of copper production associated with sustaining current operations, mining costs associated with sustaining capital, certain applicable corporate administration costs and mining equipment lease costs are included."
I dug out these costs from the MD&As, estimating full 2022 costs as twice those of the first half. For 2023, I increased the direct mining and milling costs by 5% (these already have been impacted by inflation or other factors) and the employment costs by 10%.
The outcome looks like this (all monetary amounts are in Canadian $ unless otherwise indicated). The chart follows the approach used by CMMC, deducting the revenue from selling gold and silver to get the AISC for copper only.
Note that the graphic shows total cost, which changes only moderately. How much copper that produces depends on the concentration. How much money depends on the price of copper.
We can see that through the teens these net costs ran between $50M and $60M. They are now running perhaps $65M.
In parallel with the above bootstrapping, CMMC sought both to expand and to explore more of Copper Mountain.
Taking the expansion first, in 2018, they bought what is now called EVA in Australia. CMMC does not have a history of a lot of share issuance, but that purchase was associated with a 26% increase in share count.
Exploration results at EVA have been promising. Pre-development engineering has been underway for some time.
But it is not clear that CMMC will keep EVA. From the Q2 2022 earnings call:
Detailed engineering is now nearly 50% complete, and project financing is also advancing. We are also evaluating strategic opportunities for EVA. This could include joint venture partnership or a sale; we have engaged Macquarie to assist us with this process. We expect to present all of these options to our board and make a decision on EVA in the fourth quarter of 2022.
The ultimate reason for this may lie at home in British Columbia. Further exploration of Copper Mountain, in 2018 and 2019, expanded known reserves from 14 years to 31 years.
The implication is that a significant increase in milling capacity at Copper Mountain would now make economic sense. CMMC is doing their current upgrades with an eye to getting to 65 ktpd. From the Q2 2022 earnings call:
The 65,000 tonnes per day can be a sort of a step change approach for Copper Mountain. And a lot of the construction that that Don was reporting on, a lot of that capital invested was for, in essence, 65,000, temporary case. So in order to do 65,000 tonnes per day, we needed that cleaner column, we needed that filtration in place, and they're sized for 65,000 tonnes a day. And the work that we're doing on the cleaner expansion, although you'd have to credit, some additional cells on top of that, for 65,000 is relatively minor. So those are all projects that were designed to get us to 65,000 tonnes a day.
Beyond that, CMMC is eyeing 100 ktpd. That requires a more burdensome level of permitting, and so probably will take even more time.
Crunching the numbers, starting in 2019 CMMC has been devoting a large fraction of their free cash flow to development capex aimed at increasing production at Copper Mountain. They have taken almost no funds from share issuance or adding debt.
If CMMC can get to 200M pounds of copper per year without much dilution of shareholders, that evidently would more than double their value. Selling EVA would help square the circle here. But the history also suggests that getting to that 200M level will be a 5 to 10 year process.
As a recent article discussed, 2022 has been a really bad year for CMMC. We saw above the low concentration of the ore they happened to be mining.
Some post-pandemic macro issues also impacted production, as discussed in the Q2 2022 MD&A:
Mine production has been impacted with supply chain issues impacting available parts, including parts of some of the mine production drills, drill availability, limited loss and inventory levels, which contributed to the delay in Phase 4 waste removal.
On top of that, production was reduced by the need to repair the secondary crusher once the needed parts were in hand. In July 2021, a chunk of underground steel got through the primary crushing system, wasn't picked up by their metal detection, and damaged the secondary crusher. There are quite a few details in the earnings calls.
Then on top of those issues, it turned out that the CFO had hidden his significant insider selling starting in late 2021. Doing that was about as boneheaded as you can get. But my perspective is that it is vastly more likely to reflect personal tragedy than a nefarious or corrupt corporate culture.
We will never know much about the context. Of course he is now gone, but even so the story gives CMMC a black eye.
To my mind, the thing is that this is as financially simple a company as you can find. These are mining guys, not finance guys.
They had bank financing from Japan, nearly all replaced in Q2 2021 with the issuance of US$250M of secured bonds. And they have since paid off the small amount of other debt.
At this point, CMMC has no bank debt. They keep their cash balance in the ballpark of $100M. Their only hedges or derivatives are some collars on their coming copper deliveries. This is definitely not Enron.
The upshot is that the departure of the CFO, even under scandalous circumstances, is not a major worry for me. But it probably added to the market reaction.
We now have the pieces and context to assess the free cash flow, or FCF, that this mine can generate from copper sales. Take the copper production at 90M lbs of copper per year, assume an 80% exchange rate for US$, and use $260M as the AISC (in 2023 $).
One finds FCF increasing from $78M for US$3 copper to $190M for US$4 copper and to $303M for US$5 copper. The breakeven price is US$2.30.
The current market cap is near $300M, so the Enterprise Value, or EV, is near $550M. (This takes the net debt as long-term debt plus capital leases less cash on hand.) On this basis one generates the following plot for a market cap of $300M or $200M.
If one evaluates the EV/FCF value as a fixed FCF each year for ten years, using a 10% discount rate and no terminal value, one gets a multiple of 6. My understanding from an investor with more experience in this sector is that multiples in the range of 7 to 10 are common, with higher values for larger firms having large reserves.
But as seen above, stock prices at the moment are somewhat depressed. RIO, for example, is now priced at about 7x based on current EV and 2022 estimated FCF.
You would be paying ~6x for CMMC today if the mid-cycle copper price were in the range of $3.00 to $3.50. But if the mid-cycle price is $4.00 or more, then you would be paying < 3x.
However, this valuation is not quite fair to who CMMC is or where they are going. They will push production up further, as is discussed above.
(They also will gain something if they sell EVA, but the assumption here is that those funds would go to support the push to higher production.)
Suppose CMMC manages to push copper production to 200M lbs per year, taking 10 years to do so. Running the numbers, FCF will increase at a about 10% per year (in 2023 $).
Doing the evaluation described above for the net present value of ten years' FCF, but making the FCF grow 10% per year, gives a multiple of present FCF of 10x. This next graphic shows the upside over the present price against the mid-cycle copper price, for long-term FCF growth of zero (6x) or 10% (10x).
As always with commodity investments, one's view of this will reflect what one thinks about the future of copper prices. If one anticipates mid-cycle prices in the range of $4.00 to $4.50, investment in CMMC seems pretty compelling on a long enough timescale.
CMMC would be losing money below a copper price of about $2.30. But for short periods they could spend down cash and increase debt to survive.
It would take a sustained copper bear market at prices well below $2.30 to bankrupt CMMC. This could happen; it's up to you to assess the risk.
With copper at $3.50 to $4.50, investing in CMMC is like investing in an oil or gas Exploration & Production company whose breakeven price is $40 when oil is priced at $60 to $80.
There are many other risks, detailed in the MD&As and documents referenced from them. These other risks seem modest to me relative to the long-term story.
That said, adverse developments could certainly delay their expansion of production. Some such things will happen. Perhaps ten years to expand their throughput to 100,000 ktpd of ore is too fast. If so, the upper curve in the graphic above is too optimistic.
The drop in production and the management turmoil of CMMC this year appear to me to be inherently temporary. This company knows how to mine copper, and will keep bootstrapping production upward.
As a result, there is no good reason for the magnitude of the decrease in the price of CMMC relative to that of other miners and of copper itself. My conclusion is that CMMC is clearly and significantly undervalued in a relative sense. The market has indeed over-reacted to some temporary bad news.
Since I wanted to share my understanding of the company in full, I left discussion of the market for copper to last.
For reference, here is the history of Copper prices from macrotrends:
While price increases have been far from steady, the long-term, 60-year CAGR of the copper price has been 4.7%, with a factor of 4 in each 30 year period. For comparison, the CAGR of CPI has been about 3.7%.
With the emergence of China and other countries, the real value of commodities has increased over the past 60 years. This is a reversal of the longer-term historical trend, but there remains a lot of scope for worldwide development so it seems likely to me to continue.
Even so, the past 15 years shown above make it look like the mid-cycle price for copper at the moment might be $3.00 to $3.50 per lb. If your investment needs more than that, then the only way it works out well is if we are indeed on the verge of a structural shortage of copper.
With the above as context, we can look at factors that will influence the copper market going forward.
Demand for resource-based commodities like copper reflects many contributing factors, some of which are prone to rapid change. Supply generally changes slowly, although when surprises come they often involve catastrophes like dam failures that reduce supply.
As with any mined commodity, the future supply of copper is baked in fairly far in advance. One can find lots of similar assessments on coming supply. Here is one view of the coming global supply of mined copper:
The mined supply is moving from near 20M tonnes to about 25M tonnes over the first half of the 2020s. Recycling broadly defined adds another 5M tonnes, so current total supply has been running about 25M.
The coming increase is broadly consistent with estimates of demand from electrification of vehicles and the "energy transition" through the mid 2020s. But by the late 2020s the supply will fall and there is the potential for a significant gap between supply and demand.
The bullish case for demand involves electrification. Quoting a report by S&P Global,
Copper-the "metal of electrification"-is essential to all energy transition plans. But the potential supply-demand gap is expected to be very large as the transition proceeds. … Copper demand is projected to grow from 25 million metric tons (MMt) today to about 50 MMt by 2035…
So will the copper supply double in 15 years to meet this demand? Not on your life.
It takes longer than that to get a mine started after you identify the deposit. Think permits, assessments, protests, and lawsuits. Not to mention that the necessary and essential environmental planning and study is not quick.
My personal view is that making a transition to sources of energy that have a lower energy-density, a reversal of history, is a dumb idea anyway for many reasons. If you think CO2 matters, go nuclear. In the meantime, push natural gas as a transition fuel.
But it does not matter what I think. The green-media-political complex is going to push it on us anyway.
They will fall far short of their dreams, and already are. But efforts toward these visions unsplendid will drive up demand for copper.
On top of that, it makes technical sense to electrify a large part of transportation. And even just doing that requires a lot of copper. From the same study by S&P Global:
At 100M vehicles per year with growth of emerging economies, this produces a demand increase above 5M tonnes per year (20%). That will be augmented by demand for copper-intensive wind and solar installations, likely still large and included in the much larger increase foreseen by S&P Global in the quote above.
From this perspective, copper seems likely to sustain a structural shortage of supply for a decade if not more. This may not start for a year or a few years, but it looks probable.
The bearish case has two parts. First, one can argue that the increase in the cost of copper, on top of the political obstacles mentioned above, will dramatically slow the "energy transition" so that the increase in demand will be much smaller than anticipated. This alone likely would not prevent a supply-demand gap late in this decade.
But then there is China. China has been engaged for some decades in a debt-driven expansion. In the process it has hidden a lot of bad debt.
These aspects are similar to Japan in 1990. This did not end well for Japan (nor for Russia earlier). It will not end well for China, but when and how that ending will come is not knowable.
The world consumes about 25M tonnes of copper, of which 20M is mined. China consumes about half the total, of which about 2/3 (8M tonnes) is imported, as ore, concentrate, or refined copper.
Science Direct Article pii/S0921344920302615
Science Direct Article pii/S0921344920302615
A couple years ago, concerned about China, I looked at what happened to the imports of basic industrial commodities by Japan after their crash in the 1990s. Curiously, they did not drop.
It certainly seems that the story would be different in China, since so much of their economy is involved in construction of buildings and infrastructure. But perhaps it will be less different than we might think. There are strong cultural factors driving demand for property, and there will remain a long-term source of new demand as the population as a whole sees a continued rise in standard of living.
As an example, if one assumes that China goes into their own economic crash and their consumption drops by a third ~4M tonnes), then total demand for supply from countries other than China would drop from about 20M to 16M tonnes, or 20%.
In near-term years, this would more or less offset the increased demand from the sources discussed above. It would push copper into surplus throughout most of the 2020s, with the deficit only emerging strongly around 2030.
So where are we now?
My conclusion above was that the price of CMMC stock is excessively suppressed relative to their prospects and relative to other miners. This part is a typical market over-reaction to temporary bad news.
As a result, it would make sense to me for an investor willing to ride the market cycle in copper to invest in CMMC in preference to other stocks. There is a good chance that the market will correct the relative misvaluation within a year or two.
The upside, to repair the relative misvaluation, appears to be between 50% to 100%. The price of copper could move down enough to offset this, but probably won't.
The likely catalyst for revaluation might be the second-half results, which will see higher ore concentrations and higher throughput. But this probably only works if the price of copper is stable or rising.
As to that market cycle, to my mind there is a lot of uncertainty. There are good reasons to be optimistic for the rest of this decade and beyond.
Any investor seeking a long-term hold to ride the coming supply-demand gap needs to consider the risks of the future, especially from China.
As to me, I have been invested in some oil or gas Exploration & Production companies ("E&Ps"), though never without trepidation. I know that the oil and gas markets sometimes make dramatic moves in a hurry.
Most of that investing has been when the relative undervaluation to other companies seems large and only in firms with production costs far below the current price of oil. My core investments in that space also feature a large resource base. Even so, after closing any position I celebrate getting out alive.
My decision for now is to contemplate the feedback I get from this article, and then to consider whether to pull the trigger and invest.
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This article was written by
Paul brings substantial experience in research, and in understanding and developing models of uncertain systems, from his decades working as a physicist. He wrote his first Monte Carlo model aimed at investments in 2006. He has intensively researched and modeled a wide variety of portfolio options. Among other degrees, he holds a doctorate in physics and a bachelors in philosophy. His career began with running large projects for a major research laboratory, and continued with a long, and award-winning run as a professor at the University of Michigan. He has authored nearly 300 articles published in formal academic journals, and two editions of a textbook.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in CMMC:CA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.