Copper's Supply - Demand Imbalance

Includes: COPX, FCX, SCCO
by: Harlan Kessler

Depleting supply - A U.S. Geological Survey reported a total reserve base, in 2005, of 1.6 billion tons or recoverable ore, of which 950 million tons was considered economically recoverable. Given current world demand of 15 million tons, recoverable copper may be exhausted in slightly more than 60 years. A notable environmental analyst, Lester Brown, has suggested copper reserves may run out within 25 years assuming a 2 percent annual growth rate. Of the largest copper mines in the world, 21 of 28 are not expandable, with many being exhausted by 2015.

Increasing Demand - Global copper consumption is expected to grow by 1.2 percent. Refined copper demand reached 20.4 million tons in 2011 compared with global production of 16.1 million tons for the same time period. China's demand, which has been the fastest growing of all emerging markets, accounts for over 22% of global demand. China's demand, which has been growing at 15.1% a year since 2000, was expected to slow to 6.6% growth in 2012.

Resurgence in The Housing Market - The broad-based housing recovery continues to gain momentum with most markets experiencing price appreciation. The residential housing market continues to strengthen with reduced inventories and improving buyer demand contributing to stability and growth in home prices. Approximately one-third of copper use is attributed to residential building construction. As the housing market continues to strengthen and demand for housing increases, the demand for copper will increase as well.

Automotive Market - Auto sales for the month of November were 1.14 million, the highest level for November since 2007, a 15 percent increase from October, easily surpassing the 11 to 13 percent increase expected by most analysts. Auto sales are expected to finish 2012 at 14.4 million, the highest level since the 16.1 million in 2007. In addition, demand will continue to be driven by the fact that the average age of cars on the road has risen to just above 11 years.

Demand for copper will continue to be driven by emerging markets, specifically China. While demand continues to grow, copper production continues to be challenged. The amount of copper being used is increasing while the quantity available is barely sufficient to allow all countries to access the amount currently used by the developed world.

Spot Price

The spot price of copper closed on January 9, 2012 at $3.65 USD/lb and has a 52-week low of $3.29 USD/lb and a 52-week high of $3.93USD/lb. Over the past five years copper has traded as low as $1.35 USD/lb and as high as $4.50 USD/lb.

Investment Considerations

There are a number of ways to play the potential supply and demand imbalance for copper.

The first possibility is to invest directly in one of the world's largest copper producers such as Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Southern Copper Corp. (NYSE:SCCO).

Freeport is the world's largest publicly traded copper producer. The geographically diverse miner generates 31 percent of its production from Indonesia, 29 percent from South America, 29 percent from North America and 11 percent from Africa. Freeport currently has a P/E of approximately 11.5 with a dividend yield of 3.5 percent. The Company is working to rapidly expand their copper production to take advantage of the growing demand from emerging economies. Freeport retains a strong balance sheet with a total debt to equity ratio of nearly 17. Additionally, they are committed to reduction debt obligations and returning capital to shareholders.

Southern Copper is an American based copper producer with major operations in Mexico and Peru, currently the seventh largest copper producer in the world. Southern Copper has the largest amount of copper reserves of any publicly listed company. While SCCO is more expensive than FCX given a P/E ratio of approximately 17, it is currently yielding nearly 9.5 percent. SCCO has a total debt to equity ratio of 41.5. One item that sets the Company apart is that it has the #1 ranked mine life of all producers and a low cash cost of approximately $0.65/lbs.

Secondly, you can invest in an ETF such as the Global X Copper Miners ETF (NYSEARCA:COPX). The fund holds a basket of geographically diverse copper miners. This ETF allows you to gain exposure to copper miners while reducing the risk of owning a single company, in addition to geographic diversity. The fund's largest holding at 6.44 percent is KGHM Polska Miedz SA, a Polish gold, silver and copper producer. SCCO is the fourth largest holding at 5.55 percent and 5.36 percent of the fund is invested in FCX. The largest holdings represented by country in the fund is Canada at 43.4 percent, United Kingdom with 14.3 percent and Australia at 7.9 percent.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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