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Investing in metals – glittering future ahead?

After a tumultuous year for commodities in 2020, we’ve looked ahead at the prospects for three global metals in 2021.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

2020 was a tumultuous year for commodities. The collapse in global trade when the pandemic began drove down prices for lots of key materials. But in the second half of the year commodity prices began to rise quickly, boosting profits for those digging them out of the ground.

Commodity prices are driven by supply and demand. If demand rises thanks to, say, economic growth then the price will rise. A higher price can make previously unprofitable mining projects viable, so supply tends to rise to meet the increased demand. But this takes time, so in the short run prices can be quite volatile.

We've taken a look at three global metals, their price drivers and outlook, with a focus on what key mining companies are saying about them:

Iron ore is a key industrial input. The bulk goes into steel production, because we're technologically advanced enough not to use raw iron anymore. This means demand for iron ore is tied closely to economic growth, making it relatively cyclical.

Copper has both industrial uses but is also found in lots of consumer goods. This makes it less cyclical than iron ore, but it's still closely linked to the ups and downs of the economy.

Gold is the quintessential precious metal. Gold has some industrial uses but most demand comes from, well, demand for gold. We'll come back to this.

Iron Ore

Iron ore is one of the most important commodities in the world economy, and is a key ingredient in the production of steel. China is the world's largest producer, consumer and importer of iron ore, meaning demand is heavily linked to the Chinese economy.

According to mining giant Rio Tinto, global steel production fell 1% in 2020. This reflects record production in China almost entirely offsetting the 9% fall in the rest of the world – including an 11% fall in India, the world's second largest producer.

Chart showing Iron Ore Price (US$/metric tonne)

Past performance is not a guide to the future. Source: Refinitiv, 04/03/21.

Iron ore prices were already pretty high following the Bumadinho Dam collapse in Brazil in early 2019. The tragedy disrupted global iron ore supply causing prices to rise worldwide. Prices then rose further in 2020 thanks to a strong recovery in Chinese demand. They also benefitted from constraints to global shipping and disruption to scrap collection.

However, China can only support demand for so long. Chinese steel exports fell by just over a third to 33m tonnes, reflecting weaker industrial demand in the rest of the world. Fortunately, other global production has been recovering in recent months. But if the world economy fails to recover smoothly, momentum could fizzle out.

Rio's fellow Anglo-Australian mining giant BHP is especially bullish, arguing the iron ore price can only meaningfully contract when "one or both of the Chinese demand/Brazilian supply factors...change materially". In the latter part of this decade BHP expects demand from China to slow and be supplanted by demand from the rest of the world, led by India. It's important not to take too much comfort from this – a global recession or resurgence in Brazilian supply could well materialise.

Of the miners we write share research on Rio Tinto, BHP Billiton and Anglo-American rely most on iron ore.

Iron Ore % of Revenue
Rio Tinto 65%
BHP Billiton 55%
Anglo-American 25%

Source: Company Statements, full year 2020 for Rio Tinto and Anglo-American, first half FY21 for BHP Billiton.

Rio produces almost all of its iron ore in Pilbara in Western Australia. In 2020 it cost them $15.4 per tonne in cash to dig out of the ground, and they expect costs to rise to between $16.70 and $17.70 this year. Given they were able to sell the ore for an average of $98.90 per tonne last year, the increase in costs is unlikely to make a major dent in profitability.

BHP's iron assets are also concentrated in Western Australia. The group spent $14.38 mining each tonne of ore in the second half of 2020, compared with an average realised price of $103.78. The group expects costs to be between $13 and $14 per tonne for the full year ending June 2021.

Anglo-American gets most of its iron from Kumba in South Africa and Minas-Rio in Brazil. Costs are noticeably higher for both mines, and Anglo spent $27 per tonne in 2020. The group sold its ore for an average of $112 per tonne, and expects costs to be around $34 at Kumba at $22 at Minas-Rio in 2021.

Remember, each miner adjusts its unit costs to give an underlying picture of the business, so investors need to be careful before making hasty comparisons.

Copper

Copper is as a base metal, as opposed to a ferrous (iron based) metal. Copper has both industrial and commercial uses, especially in electrical wiring and on trains because it's a good conductor.

Copper prices fell to a four-year low last March but had risen to a seven year high by December, and have continued to climb since then.

Chart showing Copper Price (US$/metric tonne)

Past performance is not a guide to the future. Source: Refinitiv, 04/03/21.

Rio Tinto says the recovery was driven by an increase in demand from China and supply constraints due to lower scrap availability and mined supply disruption. However, the miner did warn that the second wave of Covid infection was starting to weigh on the recovery in some areas.

In the longer run Rio expects the drive towards electrification and green energy to support copper demand, as well as increased government spending in the short term. BHP, which owns just under 58% of the massive Escondida mine in Chile, also reckons there's a lack of good new assets to bring online. That's thanks to a tough decade for exploration and grade decline (i.e. less coppery ore), which is likewise expected to support prices by limiting supply.

Overall, the long-term drivers of copper demand seem strong, especially as governments and companies strive to hit emissions targets. However, demand is still linked to growth in the economy, and the supply picture could still change.

Copper % of Revenue
Rio Tinto 4%
BHP Billiton 28%
Anglo-American 22%
Barrick 6%

Source: Company Statements, full year 2020 for Rio Tinto, Anglo-American and Barrick, first half FY21 for BHP Billiton.

BHP and Anglo are the most copper exposed miners on our coverage list.

BHP sold its copper for $3.32 per pound in the second half of 2020, and it cost just $0.90 to dig up. The group expects full year costs to be at the lower end of its $1.00 and $1.25 per pound guidance range.

Anglo's copper cost $1.13 per pound in 2020 and was sold for $2.99. The group expects full year costs to be around $1.20 per pound.

Gold

Gold is a precious metal, and its industrial uses are limited. When you think about it, the value we put on gold doesn't make much sense. The conquistador Hernán Cortés reportedly told the (no doubt confused) Aztecs that "I and my companions suffer from a disease of the heart which can be cured only with gold." It might not be completely logical, but we've suffered from this disease for several millennia, and it would be a brave investor that bet on a cure any time soon.

Nonetheless, the lack of fundamental usefulness makes assessing gold's value difficult. Over the last two years the gold price has ranged from around $1,300 per troy ounce to an all-time high of over $2,000. Was gold over- or under-valued at any point? I'm not sure it's possible to say.

Chart showing Gold price (US$/troy oz)

Past performance is not a guide to the future. Source: Refinitiv 04/03/21.

Barrick Gold is one of the world's foremost gold miners, owning six Tier One gold mines spread all over the world. It costs Barrick just $967 to scratch each ounce out of the earth, so the rising gold price in the graph above has been good news for profit margins.

Barrick's underlying earnings per share more than doubled in 2020, debt was fully paid down, and free cash flow (cash generated from operations, minus capital expenditure) reached a record $3.4bn. The miner attributed the higher gold price to the impact of the pandemic and the uncertainty in the economy that followed. Investors have been treating gold like a ‘safe haven' that should hold its value even in the face of a recession or inflation, though of course there are no guarantees.

Gold might well live up to its billing, but it's impossible to say whether you're getting a good price. Remember, commodity prices can behave in surprising ways, and that goes for gold too.

This article is not personal advice. If you're not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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