Talking with the 'King of Copper'

http://seekingalpha.com/article/1282...

Andrew Mickey

Copper prices have rebounded quickly in the past four months. A pound of copper now trades for $1.86. That’s up more than 40% from December lows of $1.30.

For copper to hit $2.50 or $3.00 a pound would only require another 30% to 60% gain. That’s reasonable considering what’s going on in the world.

The odds of the global economy getting back on track have improved greatly. The U.S. markets rallied in March. China has committed to hundreds of billions of dollars on new and expanded infrastructure projects. And inflation has returned as one of the real risks facing investors.

All of this is good news for copper prices. And after watching shares of leading copper producers like Freeport McMoran (NYSE:FCX) and Sociedad Quimica y Minera (NYSE:SQM) rebound 174% and 124%, respectively, from their credit crunch lows, it looks like Wall Street sees a few legs left in the copper rebound.

Six months ago, it was a completely different story…

Lehman Brothers had just collapsed. Overleveraged hedge funds faced margin calls which sparked the vicious cycle. Forced selling pushed down prices, which led to more forced selling, and on and on. Mines were being mothballed all over the world as metals prices nosedived.

But it was six months ago when Juan Villarzu predicted a hard and fast rebound in copper prices in an interview with Chilean business magazine Poder y Negocios (translation: Power & Business). To be exact, it was November 14 – just days away from the stock market lows for the year.

Why would Villarzu expect such a strong rebound? Why would he expect it to come so quickly? Why was he one of the very few people willing to make such a contrarian call?

Villarzu is one of the most experienced professionals in the copper industry. Frankly, you’d be hard pressed to find anyone more knowledgeable of copper.

He was appointed CEO of Codelco(the national copper company of Chile) in 1994. It is now the largest copper company in the world, accounting for for 10% of Chile’s annual GDP. But it wasn’t doing nearly as well 16 years ago. At the time, the state-run company was plagued by inefficiency. Even though it was mining some of the most lucrative mines in the world, it was still losing money. According to Mark Mulligan of Latin CEO magazine, “[Codelco’s] costs were out of control, productivity was low; assaying errors had inflated yield projections at some mines and a series of imprudent derivatives operations had wiped out profits.”

Villarzu led the turnaround.He has since left Codelco and started his own company, Apoquindo Minerals (TSXV:AQM).

Andrew Mickey: Juan, in market despair last November, you boldly made a call for a strong rebound in copper prices. Even executives from major mining companies were not bold enough to say this at that time. It seemed like there were two or three mines being shut down a week. What did you see in the copper market that was actually bullish at the time?

Juan Villarzu: Two things. I always thought that China would continue to grow between 7-8% even if the rest of the world has zero growth. That would mean an increase in copper consumption of about 10% annually, or 490,000 tons of new copper each year. Secondly, I know the way the industry reacts to external events.

I supposed the producers would be influenced by the negative economic expectations and therefore, would reduce production. This has occurred.The effect of both of those made me optimistic.

AM: China imported a record amount of copper in February. Do you see this demand coming from China preparing for a massive build out, building up stockpiles, or simply finding a place to spend its U.S. dollar?

JV: Before the crisis, the strategy of companies was to increase stock as they believed the copper price would continue to rise. When the crisis hit, there was a massive drop in stocks in order to generate working capital.

Fundamentally, the Chinese have a long term perspective that there will be an increase in copper consumption. As a result, they are much more willing buyers. China is accumulating stock because the price is attractive and it is a good return on their dollars, but also, because they expect the price of copper to rise.

AM: One of the most poorly understood aspects of metals markets is the scrap market (where metals are recycled and resold). How does the scrap metal market affect copper supply/demand and how transparent is that market in order to gauge supply/demand?

JV: Indeed, there is little information regarding this market; however, it has not been a decisive factor either for the demand or supply side of the copper market.

AM: When we look at oil, we know there are millions and millions of barrels just waiting on the sidelines. Tankers are sitting in port filled to the brim and oil and natural gas inventories are setting new records. Is copper facing a similar situation or does copper work completely differently?

JV: In the case of copper, we do not have a large quantity of copper stocks. Recently copper stockpiles have resumed their decline.

This is because the copper market is slightly different. There are not giant stockpiles waiting on the sidelines. There are only limited levels of copper inventory.

AM: We all know the China story. We here at Q1 Publishing really focus on the 50 years of growth ahead in India, the demographics are perfect there, and the build out of 2 billion people.

What do you see as the biggest demand drivers for copper? Is it from new refrigerators and air conditioners for growing middle classes, is it more fundamental like water treatment facilities and other big projects like that, or some combination thereof?

JV: Fundamentally, the Chinese demand is important for the great urbanization it is undergoing. The construction of new cities is required to respond to the immigration from the rural to urban centers.

This is very copper intensive... building, construction, housing, electricity and so forth. Furthermore, there are more people requiring durable goods in the market which also have a high copper content. The type of development that China is experiencing is very copper intensive.

In the future there are other applications; for example, the US EPA (Environmental Protection Agency) declared copper as an efficient bactericide in February of 2008.

Copper is special because of its “antimicrobial” properties, and is a substance that can inactivate microbes such as bacteria, fungus and virus. It has been demonstrated that some of the most toxic bacteria, fungi and virus, cannot survive when in contact with copper.

There are organizations developing this application of copper. For example, wherever hands make contact: handles, bath towel bars, malls, transportation, plumbing, industrial cooking equipment, supermarkets, packaging; there are applications for hospitals, schools, office buildings cruise ships, cages for salmon farms... the list goes on.

AM: Where do you see copper prices 6 months from now? Three to five years? And is there any reason to expect the $4 a pound days to come back – ever?

JV: I think copper will be at $2 by the end of the year, and will be above $2 next year. I do not expect the price to return to $4 (in the last cycle, the price of copper was pushed up by speculation of funds, and this will not reoccur due to new regulations that will come into play) but we could see $3 in 2011 or 2012.

AM: One area of concern we always have is political risk. You’ve worked a long time in Chile and it’s known as a mining, foreign-investment friendly place.

Do you see that staying the same way or are there some potential hidden risks the world hasn’t really figured out yet?

JV: There is no reason to be worried. Chile has a clear and important consensus regarding foreign investment and the mining industry and I see no reason for the government to change.

Disclosure: Author is long Apoquindo Minerals (TSXV:AQM).