How Cop­per has given Zam­bian Eurobonds the strong­est ever rally in 2yrs

Zambian Business Times - - FINANCIAL MARKETS -

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.

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