The commodities bust may be about to claim some brand-name victims:
A lot of big, diversified miners produce silver and gold as byproducts, so if, say, a copper mine closes because of that metal’s recent price collapse, that also takes precious metals out of the production stream and other things being equal raises their price. So far so good for gold bugs.
The weakness in the copper price has been the biggest weight on Freeport-McMoRan’s stock this year. Its price recently hit a six-year low due to growing concerns of a worsening slowdown in China, which is the world’s biggest copper market. With copper falling below $2 per pound it calls into question Freeport-McMoRan’s ability to generate sufficient cash flow to both manage its debt and fund its capex plan. It’s a plan that is based on a $2 copper price in 2016 and $45 per barrel for oil. Presently, copper is a few pennies below that level, while oil has plunged into the low $30s.
Those price weaknesses not only will weigh on the company’s cash flow, but are weighing on the value of oil and copper assets. That’s making it even less attractive for Freeport-McMoRan to pursue asset sales to pay down its large debt load. In fact, asset values have fallen so steeply that one Jefferies analyst is concerned that “window of opportunity for Freeport-McMoRan to repair its balance sheet may have closed.” That’s after the company has yet to find a funding solution for its oil and gas business after searching for alternatives for more than a year.
The trader and miner’s credit default swaps increased to as much as 946 basis points, the highest since April 2009 on a closing basis, according to data from S&P Capital IQ’s CMA.
Slumping commodity prices have battered Glencore, prompting it to scrap a dividend payment, sell new shares and outline asset sales as it seeks to curb debt to maintain its investment-grade rating. Copper dropped to a six-year low amid a rout in metals as muted Chinese inflation increased concern that demand from the world’s largest buyer of raw materials will slow.
“CDS levels are driven by commodity prices and in the case of Glencore, especially copper,” said Max Mihm, a Frankfurt-based portfolio manager at Union Investment, which holds Glencore bonds among assets totaling about $271 billion. “If prices fall further and stay low Glencore will need to do more to protect its IG ratings.”
But fans of gold and silver streaming companies, including this writer, are watching the carnage in copper and oil with mixed emotions. Many of the miners now teetering on the edge of insolvency have cut deals in which they promise to sell their byproduct gold and silver to streaming companies in return for big up-front payments. That money may now be at risk.
Franco Nevada, the biggest streaming company, recently paid Canadian miner Teck Resources $610 million for a future share of the silver produced by the latter’s Peruvian mine. The number two streaming company, Silver Wheaton, has paid Glencore and Valeover $1 billion for portions of the gold and silver produced by some of their mines.
What happens if some of these miners subsequently go bankrupt? That’s not clear, but it can’t be good for the streaming companies whose cash will be tied up (at best) and might simply disappear.
Meanwhile, the never-ending precious metals bear market is producing a steady drumbeat of smaller gold and silver mining failures, some of which are streaming company partners. Most recently, Rubicon Gold fell to effectively zero after announcing that oops, its reserves were only one-tenth of what it had previously promised. Streaming company Royal Gold is on the hook for $75 million to this one.
Looking on the bright side, the streaming companies are highly diversified, with dozens of deals spread around the world. So the failure of any one — even a big one — probably isn’t an existential threat. It is, however, a near-term problem for buyers of these stocks. But also possibly a long-term opportunity if the streaming companies get swept down in the general carnage.