How Copper has given Zambian Eurobonds the strongest ever rally in 2yrs
COPPER has been on a winning streak since 2016 and the momentum has been on an accelerating trajectory. Having started January 2016 at $4,331/metric ton copper has gained over 66% to $7,188/ton levels on the London Metal Exchange driven by various factors ranging from growth pulse in China and the United States (post Trumps election) to market sentiment around strikes in South America (Chile and Venezuela) and regulations around scrap metal bans in China.
Zambia has 3 eurobonds running totalling just under $3billion issued in 3 tranches namely the $750million celebrated debut in maturing in 2022 (24x oversubscribed), the $1billion offering maturing in 2024 (4x oversubscribed) and the $1.25billion maturing in 2027. One key thing that comes out is that as years went by the appetite for the issuances was dwindling and is correlated to the weakening commodity pricing (copper) an inversely related to the price of the issues.
At a time, the price of copper was at $4,331/ton credit spreads on Zambian dollar bonds were over 1,241bps (12.41%) above 10yr US treasuries. The bonds for maturity in 2022 to 2027 all traded for yields of between 13%-14% (very wide margin from issuance levels of 5.25% for the 2022, 6.875% for the 2024 and 9.375% for the 2027. Credit spread measures the riskiness of a sovereign – country – so the wider the credit spread the more risk a nation (counterparty or issuer of the bond is). Eurobonds are priced using US treasury as a benchmark plus a risk margin called Z or Credit spread. So to factors will impact the price of a bond namely the US treasury yield volatility and the credit spread which is function of a nations credit rating and other factors that determine its credit worthiness to include revenue generating capacity such as commodities that it depends on for revenues or taxes. For Zambia copper is key driver for economic growth and the average investor pegs the price of its bonds to the price of copper meaning if copper is doing well then sentiment improves and the price of the bonds rises because their demand soars. (Remember that there exists an inverse relationship between price and yields so then the higher the price the lower the yield.).
Most African nations have appetite for dollar bonds especially to plug budget or fiscal deficits deficit the uproar from most multilateral warning institutions like the International Monetary Fund – IMF, World Bank and Africa Development Bank. However low spreads on Eurobonds means it is cheaper for nations to go in and sell or issue bonds. This will assist with managing interest cost. The interesting observation is that when most countries need the funding the timing is usually wrong as it always comes when spreads are highest as a function of low commodity prices which make investors exhibit scepticism to take risk. Low spreads signify an open window for cheap funds.
The ministry of finance has hinted that Zambia may in 2019 make a 4th appearance in the international capital markets to refinance its almost maturing 2022 bond. The purpose of refinancing would be to spread the lower cost and to raise dollars to avoid potential defaults on maturing bonds. The copper price rally then becomes a good barometer of the yield on Eurobond as further increases in the red metal price on the LME will further narrow the credit spread risk on Zambian bonds which will lower the yields and simultaneously increase its price. However questions that most will ask is will copper continue to trend bullish in 2019? What if it doesn’t and eurobonds become costly what other options will the nation have to refinance its 2022’s?
Global markets are watching which direction copper will take after crossing the $7,000/ton mark as this will be a statement that will determine how most copper dependent nations, mining decisions, mining stocks and copper related business will strategically position themselves. Global growth is estimated to hit 3.9% in 2018 and since copper is a barometer of global growth we expect that it will continue pointing north. Traders are already taking option bets of $10,000/ton signaling the confidence and optimism in the red metal.
The Eurobond rally has benefitted most commodity dependent nations such as Angola and Nigeria that have leveraged of crude, Ghana and Ivory Coast that have benefitted from cocoa pricing while Zambia and DRC have appreciated the copper rally. In general African dollar bonds outperformed emerging market - EM assets in 2017.
Yields on Zambian dollar bonds at Friday 04 December close of business were 5.865% on the Sept. 2022, 6.384% on the Apr. 2024 and 7.087% on the Jul. 2027.