Why Copper Is Hotter Than Gold
10/05/2010 9:23 am EST
Copper, that other shiny golden metal, is just as hot as gold is right now. And I think the fundamentals for copper are better.
But after the extraordinary run on these stocks—Freeport McMoRan and Taseko were up 37% from the August low through the close on October 5, and Southern Copper, the laggard, was up 32%—I’d look for earnings-season volatility to give an opening for a buy or two.
Some of these gains I’d mark down to the commodity traders. Hedge funds have moved almost as heavily into copper as they have into gold. Demand for copper as a bet on global economic growth and as a hedge against currency chaos has helped drive the price of copper on the London Metal Exchange to more than $8,000 a metric ton. That’s roughly a tripling in price since the start of 2009.
From this perspective, copper at the moment is like gold—a bet on the macroeconomic future. With copper, the bet is on continued declines in the dollar and an increase in demand from the global economy, particularly China. (For more on why gold has been so strong—and will continue to be so—see this post.)
Right now, observers say, Chinese companies are running down their inventories in an effort to postpone buying at currently high prices. Chinese companies have enough inventory to get them through the end of the year before they have to begin buying again, according to London copper traders.
It’s on the supply side, though, that copper is different and where it is a fundamentally better story than gold, in my opinion.
Production at older copper mines—those opened in the 1980’s—is declining as miners dig their way through the richest ore bodies and begin to work lower-grade ores. That means a company has to move and smelt more rock to get out the same amount of copper. That, of course, is more expensive, but at some mines, it’s also just not possible: If a smelter has a capacity of 100 tons, that’s all the rock a miner can run through the smelter, no matter what the grade of the ore.
With lower grades of ore containing less copper per ton of rock, production falls. So, output from the world’s top four publicly traded copper producers declined by 12% in the first half of 2010.
Increasing production isn’t quite as simple as it sounds—even if you think that creating new mines in increasingly remote and unforgiving locations doesn’t sound particularly easy. Not only does a company need to find a new deposit of copper, but getting the copper in that deposit to market has to be economically viable (we’re talking about building railroads and ports, for example), the ore has to be of a higher grade than in existing older mines, and the political situation has to at least allow the mining company to delude itself into believing that it stands a good chance of actually owning the concession by the time production starts.
All this means that when copper stocks go into rally mode again, I want to own pure plays—Freeport McMoRan rather than BHP Billiton (NYSE: BHP)—with lower-than-average costs of production, and for the long term a decent pipeline of promising new mines under development.
That description would put Freeport McMoRan at the top of my list, followed by the very volatile Taseko, and then Southern Copper.
I don’t want to buy any of these just yet. There’s a good chance that we’ll see a dip in the very short term. I’ll have more on a specific pick if prices move the way I’d like them to—or when I give up waiting for even a mini-correction in the industry.
Full disclosure: I don’t own shares in any company mentioned in this post in my personal portfolio.