If you’re watching the Glencore rollercoaster and wondering what’s driving it, then this chart from Morgan Stanley might help you understand why some analysts think the mining company’s stock is worth nothing, and why other analysts want to know the extent to which banks are exposed to Glencore‘s ability to pay back $US30 billion in “net debt.”
The chart shows the price of copper historically versus the ability of mines to dig it out of the ground at a cost less than that price. The fortunes of Glencore are heavily dependent on the price of copper:
The two “cost curves” (red and yellow) represent the percentage of mines able to produce copper at the given price. The red line represents the 90th percentile of producers. With a copper price at the level of that red line, 90% of mines can produce it and stay profitable. Similarly, the yellow line shows the 50th percentile, the price at which half of mines would still be profitable. (Reuters has a good explanation here if you want more.)
So, from 1980 to about 2004, the price of copper appeared to have a fairly predictable relationship with the 90th percentile of producers. As the price rose above the 90th percentile, more mines were opened and the total number of mines (and copper produced) increased.
As the price declined, more unprofitable mines suspended operations, and the line declined. Most of the time, this relationship between the price of copper and the ability of 90% of mines to stay in business clings roughly together. Only rarely does the price of copper sink to a point where it goes below the costs of 50% of mines.
Today, however, that relationship seems to have gotten out of whack. In the mid-2000s, during the commodities boom, the copper price went way above the costs of 90% of mines. Mines that would have previously been massive loss-makers could easily turn a profit — so more were opened.
And even though the price of copper has halved, from $US10,000 per metric tonne to about $US5,000, that price is still above the 90% level on the cost curve.
This is good news for Glencore.
Unless, of course, there is a recession. In which case, according to Morgan Stanley analyst Menno Sanderse and his team, this might happen:
Global recession: in 1982 the sector traded on a trailing P/B of 0.47x with RoE of 5.0% compared to 0.85x and 7.9% today. This was during a sharp global recession with global GDP growth at 0.5%. During this period copper traded around the 50th percentile of the cost curve … On current cost curves that would suggest 46% downside to a copper price of USD2,780/ton
But do not panic!
Sanderse is not suggesting that we’re about to go through 1982 all over again. Morgan Stanley’s estimate is that global GDP for 2016 will be around 3.3%, well above that of 1982.
Nonetheless, the chart is a useful reminder that most of the time the price of copper is around $US2,500 per tonne, not the $US5,000 level we’re currently at. And the right-hand side of the chart appears to show a dramatic price correction taking place.
No doubt Glencore has this covered.