Volatility has a habit of making investors feel as though they must do something. In resources, that impulse can be costly, because commodity cycles punish overconfidence - particularly when prices are being propelled as much by narratives as by fundamentals.
Today, investors are being pulled in several directions at once: excitement about electrification and AI-linked infrastructure; a renewed appetite for “real assets”; and fresh geopolitical risk flowing through energy markets, most visibly now with the conflict in Iran.
At the same time, Australia’s recent equities reporting season reminded us (again) how aggressively markets can react to incremental data, often amplifying momentum rather than durable value.
This paper will delve into how and why we anchor our commodities exposure to first principles rather than headlines. Namely: where are we on the cost curve, what is the incentive price, what is the asset life, and what am I paying for each tonne of sustainable production?
It’s less about demand, more about supply
Commodity commentary often leads with demand forecasts: electrification, AI, data centres, reshoring, defence spending. Many of these themes are real. The problem is that markets tend to overpay for the story and underplay the mechanism that actually sets commodity prices over time: the supply response.
Even where demand growth is strong in total terms, it often looks far less dramatic when annualised. A headline touting “70% copper demand growth over 25 years” sounds extraordinary, yet translates to an annual growth rate of roughly 2%.
That is meaningful but not magical. Prices are ultimately determined by the marginal unit of supply required to balance the market.
And markets must clear at some point. Persistent deficits on paper cannot persist in reality as once any inventories are consumed, demand has to equal supply. The price moves until demand moderates, substitution emerges, scrap flows change, and new supply becomes viable.
While demand is somewhat cyclical, the volatility and size of commodity price cycles are almost always driven by supply-side factors - particularly the sector’s near-universal tendency to act procyclically and mining companies’ historically poor capital allocation. This tends to lead to over and underinvestment at exactly the wrong points in the cycle.
Looking at copper, aluminium and lithium below, two obvious conclusions emerge.
First, demand - particularly for the more mature commodities such as aluminium and copper - follows a relatively steady path and is not especially cyclical. Second, the rate of demand growth shows little correlation with price movements: copper prices have significantly outperformed aluminium despite much lower demand growth. Even with exponential growth in lithium demand, prices still fell sharply as new supply came on stream, with the industry’s small scale and relative immaturity amplifying the price impact.
Iron ore also provides a classic case study, with a volatile commodity price chart through a period where demand growth was positive and relatively consistent. However because mining companies tend to act procyclically - investing when prices are high - and because new supply often comes on stream in large increments, this investment frequently results in oversupply and the resulting downward pressure on prices.
The chart clearly demonstrates the correlation between price direction and the supply demand balance, with the latter typically being due to supply decisions from the miners.
Cost curves: the investor’s compass when the chart goes vertical
In commodities, the cost curve is the compass that stops you from getting swept away when the price chart starts heading into the stratosphere. Cost curves have their limitations and represent just one tool in assessing spot prices and forming views on sensible long-term prices. However, the chart below shows just how far the current spot
price is above the entire industry cost curve - with even the highest mine on the planet enjoying 40% margins.
When spot prices are far above the incentive price needed to bring on new supply, it should trigger a basic question: how much of today’s profitability is cyclical and how much is sustainable? If you assume today’s margins are permanent, you will almost always overpay near cycle highs.
This is where it is helpful to separate:
- operating cost curves (cash costs that set the short-run pain threshold), from
- incentive prices (prices required to fund and justify new supply, including capital intensity, jurisdictional risk and return hurdles).
If credible projects earn attractive returns at prices well below spot, the market is signalling that the current price is doing more than “incentivising supply”. It is likely embedding scarcity and fear that may fade.
The “pure play” copper trap
It sometimes feels that anyone presenting anything but an extremely bullish view on copper is likely to be put in a straight jacket and taken to the padded cell but we do believe bringing some balance to the debate is worthwhile. As with any other sector or security, the price you pay is far more important than whether the current dynamics or “story” are positive.
A good analogue is the technology stocks in the middle of 2025, when businesses that we had and still have a lot of admiration for were trading at considerably higher levels in large part due to supposedly bullet proof uber bullish projections. It has been a good reminder that positive fundamentals can be mispriced on hubris and the price you pay is always the ultimate arbiter.
In no way is our view on copper bearish. We see a relatively positive supply demand dynamic prospectively. However experience has taught us that commodities by definition are cyclical and do not move in straight upward lines. When markets are only ever reacting positively to news, we believe caution is warranted. Longer term demand drivers such as AI and the associated data centre requirements are heralded as reason to push near term prices up (despite the obvious lag to when any copper will actually be demanded) whereas supply side growth ambitions are largely discounted due to their longer dated impacts.
As noted in the earlier copper cost curve above, the highest cost producers in the industry (90th percentile) are making north of 50% cash margins before capex, which is both highly unusual and a signal of pricing very much towards the top of the cycle. Prices can deviate in times of acute tightness (the “fly-up” pricing BHP loves to reference) however with US copper inventories rising aggressively in the past 6 months and Chinese stocks moving in a similar direction in more recent times, it is clear that the copper market is in surplus, rarely an environment for such high pricing.
Whilst our view is the copper price is unjustifiably elevated, we would argue that valuations of pure play copper equities are even more extreme where investors hunting for maximum torque to the commodity price are driving up prices. The problem is that torque works in both directions, and pure plays can become priced for perfection.
A useful shortcut (with caveats) is to look at the implied valuation per tonne of annual sustainable production embedded in a company’s market capitalisation. For long-life, high-quality assets this can be informative; for short-life, high-cost or heavily development-dependent assets it can mislead.
But when implied valuations move to levels that dwarf replacement economics, the warning light flashes red.
Investors are currently paying north of US$100k per tonne of annual copper production capacity in equity value, a lofty premium to brownfield expansions which are generally closer to US$20k per tonne and greenfield projects in the order of US$30k per tonne.
Assuming the same investor would like a 10% return on this investment, the cashflow, after capex, must equate to US$10k per tonne (and higher for the even more aggressively priced equities). Even if one uses the current, and in our view elevated, copper price of around US$13k/tonne , margins approaching about 80% are required – highly unusual in any year but unprecedented as a perpetuity margin in any commodity. That’s a precarious assumption once you account for royalties, wage pressure, government take, sustaining capex, and the political economy that tends to emerge when miners earn super-normal profits.
This speaks to the current risk: the market is not only pricing a high spot copper price into perpetuity, it is pricing extraordinary margins into perpetuity.
Aluminium’s underappreciated supply-side risk
Aluminium has been the poor cousin to copper for decades, and for good reason - supply. Aluminium capacity is not particularly hard to build out (no significant intellectual property) and the raw material in the ground, bauxite, is ubiquitous. This suggests excess returns in aluminium should be fleeting. And history would concur with that conclusion.
But another commodity input into aluminium smelting is becoming scarcer: power. Specifically, appropriately priced power is becoming hard to come by. This, combined with a Chinese cap on aluminium capacity at roughly current production levels, is turning the supply side on its head with future growth becoming relatively hard to identify. With other sources of electricity demand - most notably data centres, alongside the broader electrification trend - there is a real risk that little new capacity is built and that some existing capacity is forced to shut when power contracts expire. With demand growth expected to continue at relatively healthy levels combined with a far more subdued supply side than history, we see the backdrop for aluminium as very positive and more importantly, in some cases, positive relative to market views on the industry and equity pricing.
Beyond this structural supply setting, the shorter term is also being supported by the conflict in Iran where Middle East aluminium production represents around 10% of global supply. With both electricity supply and the supply chains bringing raw materials to the smelters under strain, continued smelter production in the region is at serious risk. Two smelters have already curtailed output, and others may follow if the conflict is prolonged and the Strait of Hormuz remains closed. Unlike other commodities which can respond very quickly to any alleviation in these conditions, aluminium smelters can be slow to restart once shut - often taking months, not days to resume production. If conflict disrupts power supply or raw material logistics in key producing regions, the impact can outlast the news cycle. Even if the geopolitical situation improves quickly, capacity that is taken offline can create a longer-duration tightening than the market initially expects.
For Australian investors, that matters because companies with aluminium exposure, directly or indirectly, can experience genuine cash flow sensitivity to price moves, not just thematic “optionalities”.
The aluminium price and the equities exposed to the commodity have rallied strongly in the past 6 months, delivering a large amount of the upside we previously observed. That said, we would still see the equities in this sector as priced far more sensibly than the extreme cases we observe in the copper market referenced earlier.
A note on Iran
Geopolitical instability is dominating headlines, and commodities markets sit right at the centre of this.
When conflict escalates in the Middle East specifically, the market’s first instinct is to reprice oil because oil remains the economy’s most immediate and pervasive input cost. The Strait of Hormuz is a critical artery for global energy flows, and risk premia can expand quickly when the probability of disruption rises.
Two points matter for commodity investors:
1. Oil shocks are fast-moving and sentiment-heavy
If the conflict de-escalates and infrastructure is not materially damaged, oil can normalise relatively quickly.
2. The second-order effects are uneven
Higher energy costs can pressure margins across mining, processing and logistics, but they can also lift inflation expectations and complicate the macro backdrop, supporting “hard asset” positioning even as they raise operating costs.
In other words, geopolitics can boost the bid for commodities and commodity equities, while simultaneously increasing parts of the cost base. That tension is why valuation discipline matters most when headlines are loudest.
Diversified majors: less exciting, often priced more rationally
Diversified majors like BHP and Rio Tinto can offer copper exposure at more reasonable implied valuations once accounting for the rest of the portfolio. Investors do not get the same “pure copper” narrative, but they often get:
- lower-cost, longer-life, higher quality assets;
- better balance sheets;
- greater resilience to a single-commodity downturn.
This does not mean the majors are “cheap” versus their own history, but relative to an expensive overall market, and relative to the pure play equities, we see them as reasonably priced. Essentially it means the shape of the risk can be more forgiving - particularly if management avoids the temptation to chase pure plays at inflated prices.
Conclusion
Markets will keep oscillating between fear (geopolitics, inflation, recession) and excitement (electrification, AI, reindustrialisation). Australian resource companies sit at the centre of that tug-of-war.
The investor’s edge is not predicting the next headline. It is staying calm while others extrapolate, and returning to the same questions: where are we on the cost curve, what is the incentive price, what is the asset life, and what am I paying for each tonne of sustainable production?
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