Bright and Shiny Upside for Copper and Gold Miners, Part 1

by: Gary Dorsch
For traders in the metals markets, Freeport McMoran Copper & Gold (NYSE:FCX) ranks among the crown jewels of the global mining industry. FCX is the world’s #2 copper miner - second in size only to Chile’s Codelco. It also ranks as a Tier-1 gold miner, - the fourth largest. The quantity of metal reserves under its control is enormous - including 102 billion pounds of copper, 40 million ounces of gold, 2.5 billion pounds of molybdenum, and 267-million oz’s of silver.
A rare hybrid between a copper and gold miner, FCX is a favorite trading vehicle for speculators in the marketplace. FCX’s mettle was tested during the heightened panic of the global credit crunch in the fourth quarter of 2008, when its share price plummeted to as low as $15.70 from a record high of $127 /share less than six-months earlier. FCX’s 8.25% note due in 2013, plunged to as low as 66-cents on the dollar, to yield more than 17% to maturity, as the price of copper plunged to $1.25 /pound in New York, just slightly above FCX’s estimated cash cost of production of $1.04 /pound.
But FCX’s executives quickly found several ways of slashing costs, such as reducing capital expenditures and cutting its dividend, to preserve precious cash. Excluding one-time items, FCX still managed to eked out a small profit of $23 million in the fourth quarter of 2008, when market conditions looked the bleakest. As fate would have it, China’s State Reserve Bureau, (SRB), rode to the rescue of the global metal miners, - buying roughly 45% of the world’s base metals supply in 2009.
Speculators spotted China’s stockpiling spree, jumped on the bandwagon, and red-metal rallied every quarter last year, posting an annual rise of 140%, its biggest in three-decades. One year later, FCX, with a portfolio of assets including the Grasberg mining complex in Indonesia, the world’s largest copper and gold reserve, posted Q4, 2009 earnings of $971 million, while its revenue more than doubled to $4.6 billion, from $2.1 billion a year earlier. During 2009, FCX repaid $1 billion in debt, leaving it with outstanding debt of $6.3 billion and cash of $2.7 billion.
With its fourth-quarter mining costs for copper falling to an average 62 cents /lb, the company expects its operating cash flow to approximate $5.3 billion this year. Reflecting this optimism, FCX Gold is an international currency, and thus, support or resistance can come from many different quarters around the globe. The largess of G-20 governments, providing $14 trillion of various stimulus packages, and guarantees for banks, has spawned all types of speculative activity, including the most opaque form of derivatives - credit default swaps (CDS), which played a key role in driving Lehman Brothers (OTC:LEHMQ), Bear Stearns and American International Group (NYSE:AIG) into bankruptcy.
China’s exports are growing again, up 45% from a year ago, and “hot-money” inflows are rising, adding to the pool of cash sloshing about the Chinese economy. China’s stash of foreign currency reserves has mushroomed to $2.4 trillion. At the same time, in order to keep the yuan tightly pegged to the US dollar, the PBoC is buying vast quantities of US dollars, Euros and yen for its FX reserves, and is printing huge quantities of Chinese yuan, - fueling dangerous bubbles in stocks and real estate prices, and blowing bubbles in the Shanghai commodities markets.
Gunslingers were able to return to the gambling table, fully aware that their losses will be covered up in future by G-20 governments. This has led Oligarchic bankers to intensify their involvement in the most hazardous forms of speculation. Based on the near-zero interest rates, finance houses are able to borrow funds at next to nothing, and can easily engage in carry trading in liquid commodities or stocks. has rebounded to as high as $90 /share on January 10th. Since then, its shares have gyrated on a mini-rollercoaster ride, slumping to as low as $66, in a violent shake-out, before rebounding to $80 /share today. For all its valuable assets, Freeport’s market value is just $36 billion.

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On March 2nd, Richard Adkerson, CEO of Freeport-McMoRan, said:

Business is still weak for us in the developed world, in the US, Japan and in Europe. But the long-term outlook is good. When you add in any recovery in the developed world, with the opportunity in China and other developing countries, (such as Brazil, India), you get a positive outlook for demand in the long run.

China has become a key focus for metals traders in recent years, accounting for 4% of global metal demand 25 years ago to 45% in 2009. China consumed 46% of the global steel supply, much of it produced internally, leading Chinese steelmakers to import a stunning 630 tons of iron-ore in 2009, up 41% from the previous year. China has a long-standing policy of stockpiling commodities to smooth out price spikes during the year, and spent 72 billion yuan, to bolster its stash of non-ferrous metals, with imports of copper up 63%, and aluminum up 160 percent.
Last year, Chinese banks answered Beijing’s call to open the floodgates to boost the economy, by issuing a record 10 trillion yuan ($1.5 trillion) in new loans, while the government spent 4 trillion yuan on infrastructure projects. The combined stimulus equaled a stunning 45% of China’s $4.3 trillion economy. By the fourth quarter, China’s economy was rebounding at a +10.7% clip, the fastest pace in two-years, while its imports hit a record $112-billion in December.
China’s appetite for imports also aided other Asian industrial giants, such as South Korea, and Japan, - big importers of crude oil, coking coal, copper, and iron-ore. As such, speculators in FCX and other metal miners, found success, by tracking the direction of the Shanghai red-chip index, - viewed as a real-time barometer of the Chinese economy. At their peak in January, the big-3 base metal miners BHP Billiton, (NYSE:BHP) Rio Tinto, (RTP) and Brazil’s Vale (NYSE:VALE), were valued at $510 billion, equaling 26% of the $2 trillion value of the world’s top 100 miners.
After peaking at $90 /share on Jan 11th, shares of FCX, ranked in ninth in value among global miners, was seen as ripe for profit-taking. Shares of FCX endured the first meaningful correction in more than a year, skidding 27% to as low as $66 /share. The catalyst for the sharp sell-off, was a surprising move by the Chinese central bank, tightening its monetary policy for the first time in eighteen-months, by hiking banks’ reserve ratios a half-point to 16%, - a move that rocked global financial markets, base metals, and other industrial commodities.

PBoC economists are worried that the consumer price deflation experienced through most of 2009, is quickly flipping to escalating inflation in 2010. If the PBoC doesn’t tighten its monetary policy, consumer price inflation could easily accelerate at a +6% clip in 2010. With food and energy accounting for half of China’s consumer price basket, soaring commodity prices are a ticking time bomb. Social unrest is the main reason why the Chinese ruling authorities worry about inflation.
The People’s Bank of China, (PBoC) now finds itself far behind the “inflation curve.” The CRB Commodity Index, measured in Chinese yuan, has made a stunning U-turn, rebounding sharply from an annualized rate of decline of -50% in July 2009, to positive inflation rate of +35% today. In turn, the Chinese producer price index (PPI) was 5.5% higher in January than a year earlier. “The People’s Bank of China is worried about imported inflation and is monitoring the impact of international commodity prices,” warned deputy central bank chief Su Ning on March 5th.
Milton Friedman, the champion of monetarism, would have been vindicated by last year’s explosive growth of the Chinese money supply, and its latent impact on the inflation rate. Milton Friedman observed:

Central bankers always try to avoid their last big mistake. So every time there’s the threat of a contraction in the economy, they’ll over stimulate the economy, by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one.

Significant changes in the growth rate of money supply, even small ones, impact the financial markets first. Then, they impact changes in the real economy, usually in six to nine-months, but in a range of three to 18-months. The leads are long and variable, though the more inflation a society has experienced, history shows, the shorter the time lead will be between a change in money supply growth and the subsequent change in inflation.

Continue to Part 2 >>

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Disclosure: No positions