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Dr. Copper Addicted to China! A Diagnosis for Profit

What is Doctor Copper telling investors today? I for one believe it is important to listen and learn from the this particular "doctor".

When it comes to tracking the health of a national or global economy, there are few better tools than copper. That's because the reddish gleam of copper tracks its way straight through every thread of modern industrial economies.

Starting with the resource and mining sector, copper shows up in every aspect of the economy:

  • from housing to automobiles

  • from generators to high voltage power transmission

  • from appliances to sophisticated electronics.

Copper is at the core of so many systems that changes in demand for the metal can provide an early diagnosis, signaling important trends for investors. That's one reason for the nickname: "Doctor Copper".

China has risen to become the world's largest copper user over the last decade, consuming an impressive 40 percent of global demand. With continued economic weakness in the U.S. and Europe, Chinese demand has emerged as the leading indicator of copper pricing.

Bloomberg signaled a potential rebound in copper recently with a report that China has drawn down its inventories very sharply. Stockpiles have been reduced by as much as 50 percent this year.

Copper prices bounced even higher on reports that China's industrial production had grown by an unexpected 13.3 percent (year-over-year).

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Not all voices are positive when it comes to the future of copper. Soaring Chinese demand for the metal had driven prices to a high of $4.60 a pound in February. But worries about a slowdown in China drove prices back sharply, affecting the valuations of many of the global corporations that rely on copper prices for their share prices.

Chief among the concerns was the danger that severe tightening of credit in China would bite into the nation's housing boom (or "bubble", as many call it). Weakening auto sales in China also increased fears of a slack copper market. Of course stagnant construction in the U.S. and widespread weakness in western economies hasn't helped the market either.

iPath Dow Jones-UBS Copper Sub-Index ETN: 1 Year

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This ETN which trades under the ticker JJC provides a reasonable profile of copper price trends over the past year.

As you'll see, copper prices tend to leverage prices of stocks based in the mining and production of copper. They have been very good performers during the economic recovery. But only until the February price peak caused a very sharp turnaround.

Southern Copper Corporation: SCCO, One Year

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If Southern Copper's losses were disproportionate to the decline in the price of the metal, the potential gains could be equally outsized on a price rebound.

Doctor Copper's Prognosis

There are a lot of voices weighing in on the future of copper. China's luxury housing boom does seem to be in decline. And, as MF Global told Bloomberg, past declines in China's property market have foreshadowed declines in copper.

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But the MF Global Chart does not take into account a future stimulus to Chinese copper demand. Beijing has mandated the construction of 36 million new housing units for lower income families. This colossal program will stretch over five years, dwarfing anything contemplated in western economies.

China is producing substantially more of its own copper this year, and that is bound to put some pressure on demand. China's copper output was 980,000 tons last month, 20 percent more than a year earlier. Imports of copper and copper products were 255,000 tons last month, 36 percent lower than a year earlier.

But when push comes to shove, there just isn't enough copper available to satisfy China's ravenous appetite. The last word on demand goes to the International Copper Study Group. The group has forecast a 377,000-ton global shortage this year. It says high prices will last "a substantial amount of years" largely because of demand from China.

The bottom line: short term copper demand and pricing are uncertain. But the long term trend seems very likely to continue rising.

Stocks of companies heavily involved in copper production include: Freeport McMoRan (NYSE:FCX) (which also produces gold) and BHP Billiton (NYSE:BHP), the world's largest mining company.

Other names include: Southern Copper (NYSE:SCCO), Sterlite Industries (SLT) and Teck Resources (TCK) as well as the copper ETN mentioned earlier, the iPath Dow Jones-UBS Copper Total Return Sub-Index Exchange-Traded Note (NYSEARCA:JJC).

At worst, I believe that China has established a floor for copper prices. The best advice I picked up while investigating Doctor Copper was a remark from an advisor who suggested Southern Copper (SCCO) as a safe investment. As he told MarketWatch, even if copper doesn't rise sharply right away, an investment in SCCO will return a 6.45 percent dividend while investors wait for a rebound.

That's a very tempting return, with a potential for the kind of share price rise that SCCO produced just a year ago.

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