Tom Szabo

Copper: A Long Term Opportunity in the Making

Interesting that FCX's own CEO says the recent copper price is not supported by fundamental turnaround in global economy but is rather the result of unsustainable Chinese stockpiling. Rarely do we get such honesty from company management, which is basically telling you that copper is soon headed back to $1.50 and FCX to $30 or below. They could certainly both rally higher from here but that would be a reason to go short, not long (although I personally wouldn't be short anything commodity, gold or silver related between May 1 and June 30). Bottom line, copper and FCX will be spending quite a bit more time in the bargain bin so there is no harm in waiting around even though there isn't such a thing as an expert in copper, much less one who would guide you.

Commodities: Brief Correction or Bursting Bubble?

There are quite a few small "commodity stocks" where the project economics are now underwater. If commodity prices slide far enough, the same thing could happen to some of the majors. Over time, the price of a given commodity (absent a monopoly like diamonds) will be slightly higher than the marginal cost of production. This is a reality that most current (sophisticated) investors recognize by awarding P/E ratios that are subpar to the market as a whole. If we do have confirmed peak production in a particular commodity, the paradigm may very well change but this is not something we will be able to confirm until several years of declining production in spite of higher prices. I agree that if and when the mom and pops buy up this sector, there could be other new paradigms to explain the overvaluations. Investing on that basis, however, is an application of the greater fools theory and not the way any billionaire got to be that way. Instead, if you have enough patience to wait for the type of absolute proof that is required to borrow every last penny you can to buy commodity stocks, you might be rewarded in the years ahead. And I don't think it will be too late if you just chill out now and wait for it. Remember the new paradigm: several years of rising commodity prices in spite of declining annual production. If it happens, that would be true alpha.

Leveraging Up on Precious Metals Ahead of Fed Meeting

If the market does not expect the Fed to do anything at Tuesday's meeting, why would confirmation of that put any sort of fire under gold and silver prices, which are at the moment in free fall mode?

The example of copper mining is not quite correct. At 80 cents copper the miners were basically breaking even. Now at $3.00 plus copper they make a margin around $1.50 to $2.00 or more per pound. That is huge and has already propelled many copper miners to multi-bagger gains. It could be the same in reverse on the way down, assuming copper prices collapse as have already lead, zinc, nickel, etc.

We don't see this as much in gold and silver mining because the mentality is somewhat different--the gold miner wants to extend the life of his/her mine as long as possible and therefore will go after lower, previously uneconomic, grades that are now profitable to extract thanks to the higher gold price. This, too, works in reverse, allowing the gold miner to somewhat cushion profit margins. The problem here is not with the gold mine manager's attitude but rather with the gold mine investor's attitude.

Silver Wheaton is a fine company with a great business model but it has risks as well and there are also limits to its leverage to silver prices. With respect to risks, consider that the mines contracted to deliver silver streams are primarily base metal operations (with the exception of Penasquito). If base metal prices fall far enough while silver prices remain high or even rise, these mines may not be profitable and could face shutdown or decreasing production (to conserve cash), thus depriving SLW of silver production. As far as leverage, I recently wrote a comment on a Seeking Alpha piece and don't wish to repeat it here, but suffice it to say that the leverage is something like 70% (ie., if silver prices go up 100%, SLW should go up 170%). Good but certainly not legendary.

Paradigm Capital Analysts Raise Base Metal Targets

The reason given for ever-rising copper prices is the same for lead, zinc, nickel and uranium, each of which has already dropped 60% from peak levels even though a global industrial slowdown is still just a prediction. The idea that copper could also drop 60% isn't that farfetched. Industrial metal prices always return to their marginal cost of production over the long term. Currently, that price is under $1.50 but set to rise perhaps to $2.00 in the next few years (on the other hand, it could decline if high cost producers go out of business).

Electric cars won't be produced in large numbers for at least a couple of years. Even so, the average gasoline car today uses 50 pounds of copper, and SUVs clearly use much more than that simply by virtue of their size. Assuming an EV doubles the average and 10 million are produced (a BIG assumption), we are talking about "only" 500 million pounds, or 250,000 tons, of incremental copper demand.

More than that much has already been lost by the slowdown in global construction, which constitutes 40% of copper demand. I personally believe a 50% shrinkage in construction is possible when it bottoms in the years ahead, leading to a potential decline of global copper demand in the range of 1-3 million tons per year. No doubt this would be a temporary drop within the long term uptrend in demand but copper prices wouldn't care. They would fall 60%, just like zinc, lead, nickel and uranium already have.

My credentials: Holding a decent number of COMEX put options in copper (ie., putting my money where my mouth is).