Southern Copper (NYSE: SCCO) has had a good run in the last six weeks compared to some other miners. The company expects prices to get better the second half of the year and going into 2013 which means better pricing for the stock. Let's look at copper's pricing in 2012 and what effects world conditions are expected to have upon it through the rest of the year. Then, let's see how we can take advantage of Southern's present position to create an income play using options.
Why Did Southern Copper Struggle the First Half of 2012?
The struggle that Southern had the first half of the year was caused by two simple things: lower copper prices and increased mining costs. The average LME copper price was $3.67 per pound in the first half of 2012, 14% lower than in the first half of 2011. And for 2012 molybdenum, silver and zinc prices also decreased 18%, 11% and 14%, respectively. Since 77% of its revenue comes from copper, it is hard to battle the combination of falling metal prices and an increase in energy and the cost of extraction at the same time. The metal markets as a whole have been driven by the negative macroeconomic conditions. In Europe, it has been Spain and Italy as of late and in Asia, it has been China's economy slowing down.
Outlook for the Second Half of the Year
Through the second half of the year, China is expected to require more copper. This should raise the demand for the year. Inventory in the U.S. and Europe are tight, but demand is weak. In the next 12 months, the supply and demand in the United States is expected to level out. Emerging markets continue to demand more, and this should help offset weaker consumption in the previously mentioned regions. Supplying copper to the markets was not good in 2011 and conditions are supposed to carry through 2012 as supplies continue to tighten. There were numerous reasons for this, from labor disputes, to poor weather conditions, to declines in the grades of ore. Obviously this decreases any over supply that might have been. Decrease in supply should lift copper prices. This is the expected outlook for the second half of the year going into the first half of 2013.
Since the beginning of June, the stock has been in a bullish peak and valley pattern growing by 15% in the last 6 weeks. If I observe the move up through the Bollinger Bands, the recent low is noticeably lower than the previous two. This could be a sign of weakening. If it was, we would see it in the RSI indicator that shows us the strength of the movement. But all it shows us is consistency. I would say it is neutral as an indicator. It is neither showing us gaining strength or losing strength. The MACD is also showing us consistency. With an ascending triangular formation, the recent move up could signify a break out on the upside. But in order to confirm this, I would have to look at where the price of copper is going presently.
Price of Copper
Let's look at the price of copper and copper futures. Dollar-denominated copper futures become less expensive for traders who use other currencies when the dollar loses value. There you have it - a weaker dollar propels copper prices higher. One thing we might see lift the price of copper is the stabilization of Europe. As it deals with its debt crisis successfully, the euro can gain ground against the dollar again raising the price of copper. And in turn, a prolonged crisis continues to help the dollar gain ground against the euro inhibiting copper prices. The second half of the year, we need to observe China, who is the globe's leading consumer at 40% of world market. As China releases its economic reports it will also reveal the direction copper pricing will go. Copper is used in manufacturing, construction, electronics and automotive production among other applications; if China reports a growing economy, the demand for copper grows and its price along with it.
Events to Keep an Eye on that will Help You Determine Copper's Direction
- U.S. employment numbers
- China's interest rate movement. Cuts are not good for copper pricing
- Appreciation of the U.S. dollar
- Manufacturing rates
The Options Play
Although I believe that Southern Copper should continue to go up, I believe technical indicators are showing me a pullback before it continues up. For this reason I am looking for a pullback before I would play something bullish. So I am choosing a bear put spread while the stock presently is trading at $33.29
- Buy a December put with a strike of '33' (priced at $2.35)
- Sell a December put with a strike of '32' (priced at $1.75)
- Net Debit to Start: $0.60
- Maximum Profit: $0.40
- Maximum Risk: net debit
- Maximum Length of Play: 5 months
Reasoning behind the Trade
- Copper as a whole is still suppressed
- The stock has moved up and looks ready to pull back
- I do not see an immediate change that will push the stock up dramatically
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.