The Daily Update - Copper and credit

Southern Copper 7.5% 2035 was one of the star performers of 2017 gaining over 20 points and and has now tightened to less than 2 credit notches cheap on a best rating basis. Clearly, 2017 was a great year for copper prices with LME copper up close to 28% since the start of 2017.

While fundamentals are still supportive of copper we see more value in owning the 100% government owned Chilean producer Codelco: for example, Codelco 6.15% 2036 issue trades 3.7 notches cheap according to our models. Not only is this Codelco issue more attractive from a valuation perspective but it also offers the added attraction of being a higher rated credit, A3/A+/A versus Baa2/BBB/BBB+ for Southern Copper by Moody’s/S&P/Fitch respectively.

We think it is important to consider both the duration and spread contribution to the overall portfolio risk and favour a mix of higher credit quality and longer duration at this stage. Global growth estimates continue to improve in the short-term and US tax cuts will bring some boost to estimates: yesterday the IMF boosted its global growth estimates for both 2018 and 2019 by 0.2% to 3.9%. An increase in its US growth estimates of 0.4% to 2.7% in 2018 and 0.6% to 2.5% in 2019 due to the tax policy changes and its positive spillover effects to the US trading partners is one of the key factors behind this increased global growth estimate.

We see the increase the US growth rate as a short-term cyclical upswing. Our view remains that inflation will remain benign in the medium term as secular trends such as demographics limit growth rates. Plus, we think 2-3 rate hikes this year and continued tapering of bond purchases by the Fed, will temper the cyclical upturn that we are now seeing. We do not believe now is the time to add to credit risk or to take sub-investment grade exposure as spreads have already tightened considerably. As we see it the more the Fed tightens the greater the risk of a hard landing. Under that environment, high grade bonds are the place to be.