Raising Our Copper Price Forecast

The copper mining industry is no stranger to shocks that push the price of copper well above or below levels that would appear reasonable to someone focused on the long-term economics of the industry, and recent history is no exception. Copper prices have seen sizable gains and new records over the past couple of years. Emerging and developed economies, especially China and the former Eastern Bloc countries, have boomed, lifting demand. On the supply side, strikes and depleted exchange inventories have taken available supply off the table and created tight markets.

The only thing that appears certain is that new shocks will continue to batter the price of copper well into the future. Unfortunately, the timing, magnitude, and direction of these forces are often unexpected (otherwise they wouldn't be shocks). So how should you value and invest in firms that mine copper? Clearly, it's not a simple task.

At Morningstar, we've formed an approach that attempts to address some of these challenges, with the goal of generating reasonable fair value estimates for investors. When it comes to constructing our price forecast for copper, we break it down into two parts, near term and long term.

In the near term, we build a five-year copper price forecast based on our views of consumption and supply. We break down consumption trends by country, discerning which areas are driving demand and which have fallen off. On the supply side, we evaluate existing mine productivity and determine new capacity additions netted against declining ore grades and exhausted reserves. Lastly, we evaluate the shocks to the system such as the extensive strikes that took major copper mines offline this past year. Our view is that China's demand for copper will not abate substantially in the next five years and will continue to challenge the industry's ability to supply copper to the market. We believe the industry will gain ground the next two years and build modest inventories; however, it will not be enough to drive prices down to historic levels.

In the long run, the price per pound of copper should approach the marginal cost of extraction when supply and demand are in balance. For the period leading up to the recent price peak, we estimate that the marginal cost was roughly $0.90 per pound. The general trend is that marginal costs in copper mining have declined over time due to improvements in extraction and logistical innovations. We believe this trend will modestly reverse itself in the future as mining companies face declining ore grades and increased demand for environmental remediation, which has been remiss in developing countries. Improvements in technology could pressure the price downward, but we do not see anything on the horizon that would improve the cost of copper extraction. Upon consideration of these factors, we have set a long-term price target of $1.20 per pound.

Today, we increased our near-term and long-term copper price assumptions. As a result, we're using the following copper prices (per pound) in our company valuations from today on:

Per-Pound Copper Price  Assumptions ($)
	2007	2008	2009	2010	2011
New	2.69	2.34	2	2	2
Old	2.14	1.15	0.98	1.01	1.04

The case for higher industry costs over the next decade has strengthened, and we expect that China's copper appetite will remain high. However, we are forecasting fewer strikes and increases in mine production, and we therefore think enough supply will be available to meet the world's needs with a little left over to rebuild inventories from critically low levels. In the long run, as China's growth moderates, we believe that the price of copper will revert to its marginal cost of production as a sustainable supply and demand balance emerges.