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As the global economy is on the edge of potentially another recession (depending on what happens in Europe) the idea of investing in copper right now might seem a bit misplaced, but being the contrarian that I am I feel that now with volatility in the market high and copper prices being beaten down now is the time to be digging deeper into this sector to find deals.

When it comes to copper there are a lot of ways to go about playing the sector, ranging from a wide array of ETFs, stocks, and even the metal itself. Some of the more popular ETFs that many use to play the sector include United States Copper Index Fund (CPER), First Trust ISE Global Copper Index Fund (CU), and the Global X Copper Miners ETF (COPX). Even with all of these ETF options available I still find that the simplest and usually the most profitable way to capitalize on this sector is to simply find a beaten down stock that specializes in copper and buy them.

The two more popular names out there in this sector are Freeport McMoran (FCX) and Southern Copper Corporation (SCCO). Freeport McMoran specializes in not just the exploration, mining, and production of copper, but also other metals such as gold, molybdenum, cobalt hydroxide, silver, and other minor metals, such as rhenium and magnetite. Southern Copper Corp. on the other hand is primarily focused on the exploration, mining, and production of copper, with a slight interest in some minor metals. Freeport McMoran has a market capitalization of $32 billion, while Southern Copper Corp. has a market cap of $25.3 billion.

Being that both of these companies are fairly similar in both size and industry I felt that it might make sense to do a breakdown of the numbers to better understand each firm's fundamentals and overall financials. The below chart compares both companies against one another in areas that I typically like to examine prior to investing any initial capital.

SCCO

FCX

2011 Net Income (Millions)

$6,818.72

$20,880

Q1 2012 Net Income (Millions)

$621.43

$764

P/E

10.14

8.43

Current EPS

2.94

4.01

Dividend Yield

7.40%

3.90%

Price/Book

5.5

1.95

Profit Margin (2012 Q1)

34.38%

21.69%

Return on Equity (2012 Q1)

58.73%

19.29%

From a pure valuation standpoint Freeport is the cheaper of the two stocks with a P/E of 8.43 compared to Southern Copper's 10.14. Freeport is also the cheaper of the two from a price to book valuation. When looking at the financial picture, Freeport had higher annual revenue in 2011. This trend also held true in this most recent quarter's numbers. Freeport posted revenue of $4.605 billion compared to Southern Copper's $1.806 billion.

The one area where Southern Copper outperforms Freeport is in dividend yield. Now, I know that yield can be a misleading indicator and a lot of the time is the sign that the stock has gotten extremely beaten up, which has indirectly pushed the yield up. When looking back over the past three months at both stocks' performance I found that Freeport that Freeport has declined around 14.2% compared to Southern Copper which has only declined around 5.6%.

Southern Copper historically has been known for paying an above average dividend to shareholders compared to that of Freeport. This yield seems very enticing, but before moving forward the question that should be asked is whether the dividend is sustainable. After examining the past several years of EPS compared to the company's dividend payout. Southern Copper has never paid out more in dividends then they brought in (with the exception for 2008, which makes sense). I will be the first to agree that the payout ratio for the dividend is quite high (around 85% to 90%), but considering the current revenue stream and margins I feel confident that they will continue to be able to pay a dividend in a range that is comparable to the current yield.

When it comes to deciding which company to buy I feel that is more a personal investor/trader choice since one firm is more of a value play, while the other is more of an income play, in relative terms. In these types of situations I will usually lean toward the stock that pays a better dividend since I am always in search of yield.

When it comes to buying one of these stocks I feel that there is still a great deal of uncertainty in the market, especially around the various outcomes in Europe, so I would be hesitant to just going in and buying any stocks out right at current prices. Instead I would suggest finding several entry point prices that seem compelling and sell some cash secured puts at those strike prices. Since I am more in favor of Southern Copper I will use them as my example for the type of trade I would suggest implementing.

Southern Copper seems to have a decent amount of support at the $28 - $29 level, with sustained support at the $25 level. I would first suggest finding a contract month that seems appealing, I like the September Puts. I like September because it gives the seller plenty of time appreciation that is built into the price as well as allowing the recent volatility spikes to be factored into the put pricing. I would suggest selling the following puts: one $25 put for $1.00, two $28 puts for $2.00, and one $29 put for $2.30, all for the September contract month. This trade would obligate me to buy 400 shares of Southern Copper if at the time of September expiration all three put contracts were in the money. If that happened I would have a combined cost basis of $27.50. This of course does not factor in the "real" breakeven I would have from the credit I received from selling the puts in the first place. The total credit that I would receive for doing this trade would be $730 (excluding commissions). This credit would offset my purchase price by about 6.63%, creating a 'real' breakeven price of $25.67.

I think it is also important to mention that in this trade there might be a situation where only one or two of the puts expire in the money. In this case the seller would get to keep the premiums from the puts that did not expire in the money, which would help further off set the "real" purchase price of the stock that was put to the to the seller.

This trade also assumes that the seller would want to potentially own 400 shares of Southern Copper (or Freeport in a comparable trade). This trade can be modified in a wide variety of ways to fit each individual's needs. I have the $28 strike weighted heavier because in the past year that price point seems to be the support level for the stock, so I am more bullish on buying at that level.

On a more macro level, I feel confident that Europe will find a resolution to its problems which should help calm global markets. I also believe that once that happens China will implement a rate cut to help stimulate its slowing economy, which would be a bullish sign for copper prices and help push up stocks like Freeport McMoran and Southern Copper Corp. Whether that happens or not the above mentioned trade is an easy way to capitalize on either situation, while we wait to see how this will all play out.

Source: Mining For The Right Copper Play