Wake Up Copper Consuming Dragon

The olympics are over China, you can start polluting again. It's time to kick up the manufacturing dragon again and start importing some copper. Copper prices have been diving since their peak of $4.00/lb from July, to just above $3.10/lb today.

This hasn't been kind to shares of Southern Copper (PCU) which has seen their shares weaken over the same time period. What you'll often hear is that investors are dropping commodities, and any shares tied to them (FCX, PCU, RIO, etc.) in favor of the strengthening US Dollar. While this is partly true, in the case of copper there are also basic supply and demand fundamentals which have caused the price of copper to drop.

The latest ICSG report sheds a little light on the build up in seasonally adjusted copper reserves.

World refined copper production has accelerated at a faster rate than consumption over the first 5 months of this year compared to the same period a year ago. This has resulted in a seasonally adjusted surplus of 31,000 tonnes compared to -79,000 tones the same period a year ago.

Copper miners obviously chased the higher prices with higher production, but what has caused copper demand to slow down? Maybe a global economic flu? Maybe China just taking a break to watch their olympic hopeful Liu Xiang fall from grace? Maybe both? Whatever the case may be, I'll be keeping a closer eye on the trend to see if I am going to be adding to my Southern Copper position.

From the company's last quarterly report, they were still exhibiting some labor problems, but have also made continuous investments in their Tia Maria mining project and evaluating a power purchase agreement to build and operate a coal-fired power generation plant in Mexico for long term integration/cost efficiencies.

China's GDP for the first 2 quarters of 2008 is running at 10.4% growth compared the same period last year [1]. If they start picking up the pace, we can expect to see copper prices rise. The main challenge will be estimating how dramatic the global slowdown will be. Potential investors should also pay attention to the company's favorable dividend yield at these levels balanced against these risks.

Disclosure: Long PCU

References:

1. National Bureau of Statistics of China

Comments

[CrossProfit:]

If this is a temporary dip due to lower consumption during the Olympic games, then this is a good set up for some 'quick & nasty' M&A activity. FCX comes to mind as being one play as shares have gone from $124 to $73, as seen on the weekly close chart here: www.crossprofit.com/vi...

It's hard to tell who will be the buyer and who will be bought as smaller companies with strong balance sheets can actually buyout larger competitors. The next couple of months should be very interesting!

CrossProfit
Disclosure: Associates long a number of names in the metals & mining sector.

2008 Sep 12 07:26 AM

[Urbane Gori...:]

Not sure why most commodity buffs prefer FCX over PCU .. The comment above is typical.. True, FCX is down by 50%... But so is PCU ... And PCU carries a very nice dividend. Further, once they get out from under their mining problems, it seems to me there should be a nice little bump that FCX would not get ...

Although FCX **seems** to be a better run company .. Whatever that really means, in a commodity driven market as limited as 'We're selling copper here!', what's the big difference... Does anyone think the Chinese, for example, really care about that?

Not knocking anyone's thinking. Just curious.

jegan ;-)

2008 Sep 12 11:57 AM

[DaveW:]

C.P./Jegan,
What are your thoughts on Taseko Mines Ltd. (TGB) as a copper play? TGB is down 175%, nice upside potential, low equity/debt ratio, $285m market cap, so it's quite a bit smaller than the big two above... Thinking of adding to my TGB position or opening new one with another (say PCU or FCX). Curious about your thoughts.
I do like your take on PCU over FCX (nice dividend).
Thanks,
Dave

2008 Sep 12 01:41 PM

[Urbane Gori...:]

DaveW.... My guess is that if copper moves up ... That 'a rising tide will lift all boats...' This is pretty common. And, I don't think anyone cares where they buy their copper. So, if PCU and FCX move up, so should TGB.

The only caveat I have to add here is that playing small cap stocks can be more of a crap shoot. Lord knows, I've lost more than my share on 'Lundin Mining' or 'Fortescue' to name just a couple. The potential upside occurs if someone gets a hankering to buy them. Which is supposed to happen with Fortescue for example. In the interim, you can suffer a lot of pain, and sometimes to extremes. Just look at the the chart for LMC on yahoo....Compare it to say BHP and you'll see what I mean.

Now go to the 'Interactive Chart' on Yahoo Finance, type in TGB and then comapre it to FCX and PCU. Look at the recent action on a one year chart. You'll notice that FCX and PCU have turned up... TGB on the other hand has not.

Most likely, the reason for that is that the big funds are not buying TGB, but are beginning to buy the other two. Until the big funds notice TGB and start buying, that stock probably will not move the same way as the other two.

So. If you want to have some fun, put a few bucks on it... But get ready to lose it too. The other thing you can do is set up your Google Home page with a gadget called "Google News - Customized" .. then enter Taseko Mines in the box.. Keep an eye on it and see what articles come out.

jegan ;-)

2008 Sep 12 03:20 PM

[DaveW:]

John,
Great advice, thank you! I just read on David Fry's post today:

seekingalpha.com/artic...

that there is rumor of an emergency rate cut, could be what's moving these names today? or perhaps a bounce after hitting support?

Anyway, thanks again,
Dave

2008 Sep 12 03:30 PM

[firboy4:]

Good to read an article and comment on this, since I in my lack of wisdom become way to heavy in FCX and PCU alone. It's like I suddenly became ravenous towards copper. Anyway, I do believe that China will someday have to buy more copper and these stocks will regain their former prices. In the meantime, PCU has pretty good dividends.
I just hope their rise is sooner than later. I think that all of this recent desire and rationalization that everything is getting better now in the U.S. will diminish when future reports of increased national debt, more job losses, etc.... come out in the news. Then people will come back to reality. It might hurt copper some, but I think China has reached the point to where it's copper needs aren't really dependent upon the U.S. economy. And when people start getting really scared from bad reports, they'll start buying up gold again.

2008 Sep 12 04:07 PM

[Urbane Gori...:]

I highly doubt we'll have a rate cut. Bernanke and Paulson need to save those last two points for when and if we have another major downturn. Look what happened to Japan. They've had an effective zero-percent rate for awhile.. It did them no good. There is chatter about it and the number of people expecting a rate drop has gone from 4% to 12% (I heard that on CNBC...) I suspect that BandP will milk the financial problems as long as possible and apply bandaids on the bleeding. This seems to mollify the public as we have a very short memory 'and' we really would like to see a turnaround. Sooner or later the economy will correct. And any rate cuts they apply will have to be painfully stripped back later. However, no-one really knows.

The hint of a rate cut is not moving anything.

What we have had for awhile is a rotating market. Imagine watching the 'Discovery Channel." You have an alligator with 'Financials written on its stomach and 'Commodities' on its back. It has a grip on the careless gnu (the market) and is performing its death-roll. So every few days the market changes from commodities to financials as it shreds everyone's portfolio to pieces.

And if you've lost money on PCU and FCX, then you are in very good company. Look at the chart for CGMFX, run by Ken Heebner... He has beat the market by a mile over the last few years.. I think one year this fund returned 80%. And anyone that bought into the 'go long commodities and short the financials' has suffered as well.

One other thing to know is that China has stockpiled a lot of materials, and copper is one of them. Google 'seekingalpha +copper _China' and you'll pull up some interesting stuff. Eventually, China will begin buying again. I just picked up some SSW (Seaspan) a container company. I listened to an interview of the CEO.. He said that since July, containers have been picking up. To me, that and the Baltic Dry Index are indicative of a beginning of a turnaround. I depend a lot on charts... And even if you are a fundamentalist, (or a beginner) I'd learn some basic stuff, such as can be found on Investopedia.com.

By the way, it isn't as sexy, but it's probably time to buy consumer non-discretionaries like P&G, Campbells, Hershys, McDonalds and etc.. Again, Look at the chart and you'll see what I mean. I've just sold FRED (Fred Meyers) after a 5% run and it is pulling back a bit. when the daily stochastic moves past 20%, I'll buy it back again... Nice chart.. Moves straight from the lower left to the upper right ....

Have fun! jegan ;-)

2008 Sep 12 06:52 PM

[BxCapricorn:]

jegan - thanks for putting out all of that information. Saw the interview with the Seaspan CEO, and also saw his previous one. He's always conservatively bullish, so I do not use him as an indicator. The BDI has been lousy, and like you, I keep expecting it to turn or do something. I was aware of China stockpiling various metals, including copper, this Spring, preparing for their dual Olympics, as well as Jiaxing Copper cutting back production (to lower energy consumption during the Olympics). Without a rate cut 9/16, and a Chinese factory restart on 9/21...although a big fan of FCX...I've got to flip to an ultra-inverse market ETF on any post Lehman deal rally, and hope for an FCX rally based on gold strength (8% of revenue). As for why FCX vs. PCU, the answer is moly, more diversified mining locations, increasing dividend and production (see FCX site and latest presentation) vs. PCU's decreasing dividend and production (650K is now 550K, announced in August).

2008 Sep 13 01:37 PM

[Pessimistic...:]

BX.. your spot on.. moly is now becoming the material sought. I think it has been around for many years and mined but now it seems to be a driving force. In is liquid state it is used as a lube.."Molybdnum" (sp). I do not think that this is the same? I know it is added to strenghten axles and the like "chromoly". It is now quite fashionable to have these metals in your vehicles for maximum durability so mining the stuff has been a front burner item.
I have been hearing about the sleeping bear ..China , and how they will need to wake up soon for our econ's sake. Yup the olympics are over and we are still waiting for the pollution to regain it's momentum. maybe they are punishing the US for their take on that belief? Who knows? Somebody set me straight.. If the best don't know why or what is the hold up.. it's guesses and opinions that rule the day.. or even speculations.
The BDI itself will bounce hard once it happens. I am expecting DRYS and FRO to feel the ease first. metal will bounce as oil exports will also rise. Yes RIO will exhult and I along with it as I fully believe the price they are seeking in paraody will be met. They are cheap right now!!
Egan hit it when he mentioned the boring but always safer consumer goods stocks. I bought CPB right after qtr. earnings and look forward to soup season.. hell, even my wife realizes their need in this ecomomy with winter coming on. Add that to my plays in GIS, PG CLX, PEP,WMT, HD, USG , capped with YUM and DRI and maybe my winter will come to fruition. I guess I got a bit defensive. I have not the faith in commodities right now they are too volatile.
Finally, China will have to make a move and hold it for me to believe we could start the train again. FCX.. PCU.. I like many will be watching close.. do not want to buy and watch it fall..again.

2008 Sep 13 03:54 PM

[Gigem77:]

Friday we saw copper prices lifted, but the reasons given are all speculation. We near the end of a quarter, next week is options expiry and the termination of the Sept copper contract. Those things are probably more influencial on price than any of those given by the news media. There is no indication of Chinese demand increasing yet. I want to see rising dry bulk rates and falling inventories.

2008 Sep 13 04:08 PM

[Socialism c...:]

Housing starts will fall seasonally as we head deeper into fall...I'm not sure we will see global demand pick up before spring. My thinking is this will be a great time to average down, and come April, when housing fundamentals as well as global economies in general are showing improvement, copper will be back up, and those who didn't panic will be rewarded. I'm long FCX.

2008 Sep 13 06:14 PM

[b3rkut:]

I'm a bit confused:

When looking at the World Wide Copper Supply and Demand chart, it shows "Usage" at 7700 tons, and "Production" at 7550.

So how can you state that there is a surplus?? Production is 150 below usage!

2008 Oct 01 10:07 PM