Finally, a company heavily levered to China has gone bankrupt. While the S&P 500 and its tracking exchange traded fund, SPY (NYSEARCA:SPY), has rallied nearly 20% since the summer lows of last year, and stocks such as Apple (NASDAQ:AAPL) are up over 30% this year, Chinese stocks and many companies heavily levered to the Chinese economy have consistently underperformed most of the major indexes.
I've written several articles, going back nearly a year, on how I thought China's real estate and infrastructure sector were grossly overbuilt during the past three years, and the world's second largest economy would likely be fairly weak for some time. While all traders and investors have good calls and bad ones, these calls were prescient. Companies such as GE (NYSE:GE), YUM (NYSE:YUM), and Apple, have had strong recent earnings in China. Still, most mineral and resources companies heavily levered to China continue to be weak. This is why I find the recent bankruptcy of Patriot Coal (PCX) so interesting. Basically the thermal and metallurgical coal markets imploded over the last year as Natural Gas prices continued to plummet and emerging market demand from China was at multi-year lows. The recent and fairly widespread stories of defaults in iron ore in China also suggest that the bulk metal market remains extremely weak as well.
While many of the leading metallurgical coal and iron ore stocks, such as Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP), Cliffs Natural Resources (NYSE:CLF), and Alpha Natural Resources (ANR), appear trading at historically low price to earnings ratios, the earnings estimates for these companies will likely have to be moderately to significantly reduced as the demand outlook for these companies continues to weak and they mark down the value of these company's reserves.
Essentially, many of the leading iron ore and metallurgical coal stocks are beginning to look like homebuilders servicing a grossly overbuilt market, rather than companies with strong and sustainable long-term business models.
This is exactly why I think there is a potential opportunity in many Copper companies, even as iron ore and metallurgical coal stocks will continue to decline in the foreseeable future. While many copper companies, such as Freeport-McMoRan (NYSE:FCX), have continually had enormous labor problems at these company's mines in countries such as Indonesia and Peru, it is exactly the problems that these companies are having today that makes copper a strong investment longer-term even as demand continues to weaken.
Copper is a supply-side story, and iron ore and metallurgical is much more heavily tied to demand. While, obviously, no commodity will rise significant without a substantial rise in demand absent a huge supply shock, copper mines are predominantly in some of the most politically unstable parts of the world, and many of the copper mines in places such as Chile continue to face earthquakes, flooding, and other natural disasters as well. Most major new copper discoveries have been in countries in central Africa and other less stable regions and countries as well.
One of the world's largest copper producers, Freeport-McMoRan, recently had to double wages and provide significant new benefits to end a labor shortage at the company's Grasberg mine, the largest copper mine in the world, and management has already forecast its overall copper production will likely drop by nearly 20% this year. Freeport-McMoRan and other companies have endured frequently labor shortages in Indonesia, and the government is also increasingly talking about imposing new taxes on mineral exports as well.
While, certainly, many iron ore and metallurgical coal sites are located in less stable parts of the world, stable countries, such as Australia, are still exporting significant amounts metallurgical coal and iron ore, and North American coal mines continue to be strong sources of thermal coal as well. Natural gas prices in North America remain weak, even while Asian natural gas prices have held up strong.
To conclude, while demand for bulk and base metals will likely remain weak for some time, not all commodities are created equal. With continued supply shortages caused by natural disasters, labor strife, and continued difficulty bringing significant new mines on-line are likely to continue to affect copper prices, it is likely the red metal will stay fairly strong, even as iron ore and metallurgical coal prices continue to fall.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.