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China's New Electricity Grid

Lots of copper needed as China, South Korea, India & Brazil build infrastructure...
MARK LACKEY, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in energy, mining, banking and investment research.
Here he tells The Gold Report's sister title, The Mining Report, about mineral investors shouldn't over-react to the apparent "slowdown" in China's economic data, and the bullishness for prices in massive new electricity grid and infrastructure builds in fast-emerging economies...
The Mining Report: Mark, the price of copper recently dipped to its lowest level since 2010. Are we going to end the year below $3 per pound?
Mark Lackey: We don't think so. We believe that the price of copper will actually recover as we progress through the year. In fact, we actually are still calling for the price of copper to trade in the $3.60-3.70 per pound range by year-end. We really haven't changed our view because if we look at supply and demand conditions, we think there's definitely been an overreaction to some of the recent Chinese economic data. Investors are losing sight of the fact that there are reasons for demand to pick up later in the year, and that the postponed production projects will impact the supply side.
TMR: Are weaker Chinese economic data the only reason behind this shortsightedness?
Mark Lackey: It's certainly a major factor. It's seems that the export data in particular got the market concerned, because if you look at retail sales and industrial production, they've been only a little bit weaker than analysts had expected. We're really talking about just two months of trade data here, so this is not necessarily a long-term trend. We would also point out that the Russian situation with Crimea has caused some concerns about European growth.
TMR: In other words, prices will remain weak in the short term, but investors should be long copper.
Mark Lackey: That's right. If you look at the new infrastructure programs planned in China, South Korea, India and Brazil, they all are scheduled to kick off this year, so we should start to see more spending later this year. That's one positive for copper.
Don't forget that China is by far the biggest consumer of copper in the world, and half the copper goes into the wire and cable business, which is growing at about 15-20% per year. We see China ending up with one of the biggest and best electrical grids in the world, but this growth should go on for the next five or six years. So there is a fairly significant built-in amount of copper consumption that's already in place. Whether the country grows at 8%, 7.5% or maybe 7% isn't nearly as relevant as some people think.
TMR: Most of the copper heavy miners have been sold off. What's happening with the juniors?
Mark Lackey: Across the board, I'd say most junior companies have lower share prices than they had three or four months ago, although some have gone sideways. You'd be hard pressed to find a copper company that's actually up.
TMR: Moving on to iron ore, some market experts believe the steep drop in the price for iron ore in early March was based on poor economic data from China, while others believe it was largely caused by a speculative play gone wrong, likely at a Chinese brokerage. What's your perspective?
Mark Lackey: First of all, some of the economic data in China in the past two months clearly affected the iron ore price. But there was also a slight buildup in inventories before the trade numbers came out, so there had already been a little bit of weakness in the market.
China also announced that it wants to shut down some small marginal steel plants that are not particularly positive for the environment, and that announcement got some analysts concerned about potentially less demand for iron ore. I think that concern is overblown. I expect bigger steel producers in China to make up for this modest drop in steel production. So we don't see a loss in demand for iron ore as a result of the consolidation that is taking place.
As far as a speculative play gone wrong, there have been a few rumors of that out there. It's hard to know if that's true. We would suggest that if it is true, it's one of those factors that is not going to have any significant impact on the medium or long-term iron ore market.
TMR: What's your forecast range for iron prices over the course of 2014? Is it above $120 per ton?
Mark Lackey: We expect prices to get back above $120 per ton, closer to the $125-130 per ton range by the end of this year. Again, like copper, we do see this increase in infrastructure spending in China, South Korea, India and Brazil as a bullish signal for steel demand. We also expect China to produce over 20 million (20M) vehicles this year, so we see steel demand rising out of the consumer sector. Meanwhile, China is also trying to increase the quality of its steel. This generally means that there will be increased demand for iron ore. Finally, supply, which increased significantly last year, should level off this year since Australia is producing at close to full capacity given the infrastructure constraints currently being experienced in the country.
TMR: Big iron miners produce iron at $30 per ton or even $20 per ton at some operations, but smaller miners generally have much higher production costs. Midtier producers are already experiencing a shareholder revolt over poor share price performance. What does all this mean for investors in this space?
Mark Lackey: If you looked around the world, the cost production for the majority of iron ore mines is considerably higher. Some Chinese production has costs of around $100 per ton. So the question becomes, will companies produce at a small profit, or will they take some of that iron ore out of the market? Our expectation is that the Chinese will take some of those smaller inefficient mines out of operation.
On a more general note, there are a number of factors that look good for the Labrador Trough, including the fact that the deepening of the Panama Canal will be finished by the end of the year. This will allow larger ships to leave Quebec and then go through the Panama Canal, thus cutting time and costs. The other recent development is the South Korean-Canada free trade agreement, which is actually very positive for Canadian iron ore producers because it eliminates the iron ore tariff. Canadian iron ore companies have a competitive disadvantage vis-à-vis some other producers who already had these trade agreements with the South Koreans.
TMR: Let's move from metals to minerals and potash. Like most mined commodities, potash had a turbulent 2013. What do investors need to know about what's happening in the potash space in 2014?
Mark Lackey: The basic underlying supply-demand scenario has not changed. In fact, we continue to see less arable land in the world per capita every year. As a consequence, there is a need for higher crop yields, and thus a continually growing market and demand for potash, particularly the muriate of potash (MOP), which is 90% of the potash market. We believe that potash prices actually will start to recover this year. There is also some other positive news on the demand side. It looks like this will be the best soybean-planting season in Brazil in history, and it looks like a strong year in the Midwestern US Plus there's been less potash used in the last few years in India, and you cannot go more than a couple of years if you want to continue to have enough nutrients in your fields. So we see this as a bounce-back year for potash and the MOP market as we go through the year.
TMR: What are your parting thoughts for us?
Mark Lackey: Don't overreact to every data point that comes out of China such that your medium- or long-term view of the world changes. Clearly, one has to recognize that there are going to be ups and downs in the commodity markets. I would suggest we're still in a long-run bull market for commodities because at least 4 billion people in the world are trying to become middle class, whereas in the 1970s, it only took about 400 million people to create enough demand to give us a very strong commodity cycle. Finally, in many commodities like copper and iron ore, we're seeing more and more deferred projects. So over the next five years, there is not going to be the supply that some people may anticipate. If you have no exposure to equities in the commodity markets, then you could very well miss an excellent opportunity over the next couple of years to enhance your portfolio return.
TMR: Thanks for joining us today.
Mark Lackey: Happy to be here.

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