Contrarian Guru's Plays in Copper

11/16/2015 10:00 am EST

Focus: COMMODITIES

Adrian Day

Chairman and CEO, Adrian Day Asset Management

While copper has lost half its value in recent years, global resources expert Adrian Day is looking beyond today's challenges. The editor of Global Analyst explains why he sees significant upside potential in coming years. He also discusses two favorite ideas for patient investors.

Steven Halpern:  Our guest today is Adrian Day, a leading money manager and editor of The Global Analyst.  How are you doing today, Adrian?

Adrian Day:  I’m fine, thank you, Steven.  How are you?

Steven Halpern:  Very good.  Thank you so much for joining us.  It is always fascinating to read your research because you walked into long-term value in places where the crowd might be running scared.  Could you explain your overall investment strategy and perhaps touch on some of the challenges for an investor who wants to go counter to the consensus?

Adrian Day: Right. Well, by its nature if you invest with the crowd, buying when it is buying, holding when it’s holding, and selling when it sells, your performance is by its nature going to match that of other people. You can’t outperform if you are always doing what other people are doing.  

The truth is that if everybody is buying, stocks are probably expensive; just as if everybody is selling that is certainly a good place to be looking for bargains.  We tend to be contrarian in that way and that is where you find value. We are not contrarian just to the sake of it, with value in this.  

We are looking for value; but, again, by its nature you find value in areas where everybody else is selling.  The danger or the difficulty is you can fall into a value trap. You can buy things that appear cheap but perhaps there is a really good reason for them to be inexpensive and they are only going to continue to decline.

Perhaps the business is in a long-term decline or perhaps the company itself is making fundamental mistakes that you haven’t quite recognized yet, you as a value investor haven’t recognized it.  

The other great difficulty that is, frequently, the case is that value investors tend to be early.  We tend to buy early and we tend to sell early. If you recognize that you can perhaps take that into account in your buying and selling.

Steven Halpern: Today we’re going to look at a specific asset class and that is copper, which is certainly an out-of-favor play; but rather than focus on the worries as most of the market is doing, you see some potential opportunity. Could you explain that?

Adrian Day: Yes, absolutely.  Well, two things; first of all, copper, and then also, particular companies.  Copper, as you indicate, or as you imply, is down almost 50% from its 2011 highs and it is down, oh, I don’t know, 30% just in the last few months. That is because of a combination of oversupply and weak demand.  

In the resource business it takes a long time from discovery to production, so you have mines that were discovered in the 1990s—or even 1980s—and then they were explored and developed.  

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When the copper price was peaking—and this is true of many resources, 2010 and 2001—a decision was made to bring those mines into production.  Bingo, three or four years later they stop producing.

They stop producing just at a time when the demand from China, which is the number one consumer of copper, has been declining. You saw mines come on at the same time as the consumption was going down and that is why we’ve seen these horrible price declines.  

If you look ahead, again, for the very same reason that I just mentioned, the long time lag between discovery and production, for that very same reason you can look four, five, six years into the future and you can be reasonably sure of what mines or what deposits are likely to be in production.  

Some things get sped up and some things get postponed; but I think one can make a statement as true.  There is no deposit that will be producing in 2018, 2019, 2020, that we don’t already know about; and so you can estimate what the production is fairly accurately looking ahead.  

The truth is that we simply don’t have that many large mines, large deposits, that are likely to come into production in the next four or five years.  The way I am looking at it is starting in 2017-2018, we should start to see a meaningful reduction in the production of copper.  

If China’s demand stays more or less stable, then we should see the price start to recover. We are already seeing signs that house buying in China is actually entering a recovery.  Home buying, of course, consumes a lot of copper.  We are looking out three, four, five years and see a shortage of copper and therefore a higher price.  

Of course, the market doesn’t wait until we actually have that shortage.  The market starts to look ahead.  Right now people aren’t looking at that.  They are looking at how bad everything is, but maybe next year, the beginning of next year, the end of next year, but at some point before it actually comes to pass, the market will focus on the coming shortage of copper.

Steven Halpern:  One way a long-term investor could invest in this trend is through one of your recommended stocks, which is Freeport-McMoRan (FCX). Could you give our listeners a little background on this company and explain how this fits in with this strategy?

Adrian Day: Absolutely, thank you.  Freeport is the largest publicly traded copper mine in the world. It has world-class assets around the world and it also is a company in the lowest quartile of cost of the cost-co, which is where you want to be.  You want low-cost production.  Freeport is a world-class company and its fortunes go up and down with the price of copper.  

A couple of years ago it acquired a couple of oil companies including a related one, McMoRan Oil and Gas and then a second one, Plains; and unfortunately, they did that right as the price of oil was declining.  

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With the decline in the price of copper and the decline in the price of oil, Freeport stock has been slammed. It is trading right now under $10 a share.  

The big problem for Freeport is its huge debt, which is about $19 billion, most of it taken on to make those two acquisitions I just mentioned.  At today’s prices it is generating cash flow and its number one objective is to cut that debt.  

It is definitely a company, in my view, that will survive and is definitely a company that will benefit from a recovery in the price of copper particularly, much more copper than oil.  

Steven Halpern:  Interestingly, Carl Icahn, the well known activist investor, has taken a stake in this firm. What role do you see him playing in this situation and will this help unlock some potential value?

Adrian Day:  No, I think, definitely.  He has almost 9% of the company purchased over the last several months.  He has publicly stated that he sees this as a three, four, five-year investment. And there is no indication that he is trying to sort of break up the company in any hostile way.  

There are plans of Freeport, itself, announced plans many months ago to look at spinning off the oil and gas company or in some way making that self-sustaining. That might be bringing in partners who will spend the money and capture a lot of a reward.  

The plans that Freeport has announced so far clearly have been taken in conjunction with Carl Icahn, but all the indications are that he is a supportive shareholder. Certainly, you can do a leverage by how the company is too leveraged already.  I think as a positive he is obviously a smart man and brings an outside view to the company.

Steven Halpern:  We only have a minute, but you also recommend a more speculative idea in the copper sector and that is Reservoir Minerals (TSV:RMC).  Could you tell our listeners a little about this company?

Adrian Day:   Yes, essentially, Reservoir has a joint venture with Freeport on a project in Serbia.  The results from that project, the drilling results from that project have simply been outstanding.  

A geologist friend I know said they were the best results he had ever seen in any mineral in his life, in any resource in his life. They are very, very strong results.  

A set of recent results...actually, what they did was they showed that the deposit it getting bigger. It is open in all directions and open a depth and a back-of-the envelope estimate will be that it could be a billion tons of mineralized porphyry.  

The important thing about that, the significance of that, is that meets Freeport’s parameters for a project that is worth pursuing.  Freeport is spending $19 million on the project this year.

And despite constant exploration all around the world—including many that are 100% held—they have kept this joint venture intact, which I think indicates that they are very, very keen on it. I like Reservoir a lot.

Steven Halpern:  Again, our guest is Adrian Day, of The Global Analyst.  Thank you so much for your time today.

Adrian Day:   Thank you, Steven.  Thank you, everyone.

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