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On the Off Chance of a Recovery

08/24/2010 1:00 pm EST


Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Mark Skousen, editor of Forecast and Strategies and High-Income Alert, says the Fed’s policy will eventually trigger a recovery, and he likes a major copper producer.

In the face of protracted high unemployment and prospects of a double-dip recession, the [Federal Reserve] officially acknowledged the economic slowdown and announced a willingness to buy more government securities and expand the money supply, if necessary.

Real gross domestic product (GDP) has slowed in 2010 from 5% in the fourth quarter of 2009 to 3.8% in the first quarter and now 2.3% in the second quarter of 2010.

The downward trend is unmistakable, and thus triggers fear of a double-dip recession.

Meanwhile, private-sector employment has stopped growing, and the unemployment rate has been stuck at 9.5% or higher.

On a positive note, the Fed’s deliberate zero interest rate policy is having some positive impact. Mortgage rates have fallen to 4.5%. Quality corporations are issuing cheap bonds. The Fed’s cheap rate policy is paying off for major corporations, and will form the foundation of a recovery.

Is the economy going to experience anemic growth or will there be a double-dip recession? This leads to a third possibility: better-than-expected economic growth. Virtually no one is banking on this. But if it happens, commodity-based stocks will soar—and quickly.

It makes sense to hedge this possibility by taking a position in Southern Copper(Nasdaq: SCCO).

Based in Phoenix, Southern Copper has the best copper ore reserves in the industry. It operates the world's largest copper mine high in the Andes mountains, producing more than 800 million pounds of copper a year.

More than 2.9 billion pounds of copper are used in construction every year, primarily in plumbing and wiring. Electronic products use more than 1.9 billion pounds a year. (Copper is second only to silver in its ability to conduct electricity.) Transportation equipment—including cars, trains, planes, and submarines—use more than one billion pounds a year. The manufacture of industrial equipment requires another billion pounds annually. And consumer and general products, from cookware to church bells to pennies, require another 800 million pounds. China’s industrial demand for copper is white-hot.

And financials at Southern Copper are first rate. Recent quarterly earnings rose 79% on a 42% increase in revenue. Operating margins top 46%. And management is earning an impressive 38% return on equity.

True, Southern Copper has been affected recently by higher energy costs and concerns about the environmental impact of copper mining. But these factors are more than discounted in the current price.

Bear in mind, base metal prices are unpredictable from day to day. So, you can expect this to be a volatile stock in the short-term. But its 5.1% yield is much higher than cash or bonds are paying. So it should be a comfortable ride up.

Buy Southern Copperat market. (It closed above $29 Monday—Editor.) And place a protective stop at $24. If you prefer to play this one more aggressively, try the December $35 calls (SCCO101218C00035000). The options last traded [near $0.65].

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