Copper May Outshine Gold In 2012: 4 Stocks To Benefit

by: Stanley Barton

Despite the dramatic increase in gold and silver prices in the past two years, the price of copper has been subdued. The red metal's price is traditionally tied to the level of economic activity, which affects the demand for the metal. Fear of inflation and economic Armageddon have contributed to a dramatic rise in the spot price of gold in the past few years, yet a sluggish US economy has kept copper essentially selling at the same price as it was five years ago.

With sprouts of economic growth muting the fears of a double-dip recession, the spot price of gold has been trending lower in 2012, and this year may be when copper breaks decisively to the upside. This article features four stocks that may benefit from an increase in the price of the red metal: three miners (large, medium and micro) and one industrial user of the metal.

Copper futures were actually up 11% in Q1 of 2012 as expectations of demand due to increased US economic activity overcame the probability of a Chinese "slowdown" to 7% growth.

The supply and demand for copper is usually well-balanced, but recent supply numbers give rise to the possibility that the demand may actually outpace the supply for copper in 2012. Barclays Capital forecasts that incoming supply this year will fall 376,000 tons short of demand this year. As stored copper supplies are depleted, the price of copper may finally succumb to the traditional supply/demand economics.

If we think that the price of copper may rise, then the miners of that metal may see a rise in their profitability, and their share prices. We should note that even though we have seen a dramatic rise in the spot price of gold in the past two years, the gold stocks did not get a boost. My article about What is Wrong With Gold Stocks: My 3 Theories discusses the possible reasons for that lackluster reaction to the increase in the gold spot price. However the industrial metal's dynamics are quite different, and we think the copper stocks may react more according to the laws of supply and demand.

Freeport-McMoran Copper & Gold Inc. (FCX) is the second largest copper producer in the world. Despite the rise in copper prices in 2012 so far, the share price is about where it started the year. The sell-off in gold during the past month may have created a buying opportunity in FCX. Although I am essentially a fundamental value investor, technicians may note that the current price appears to be bouncing off the bottom of a linear regression channel, the top of which is about $50 per share. That is a 30% price increase that may be achievable with better copper prices to push the stock higher. We think the worst of the flight from gold stocks is over for FCX, given its strong fundamentals.

Now, as for fundamentals, Yahoo lists the PE as 8, and the share price is about twice that of its book value. Book value is deceiving with miners, as they usually have reserves quite undervalued in the books. FCX has just increased the dividend to $1.25 annually, yielding 3.3% on the stock price. We should expect annual dividend increases to continue as the levered free cash flow for FCX is more than $4 per share. Essentially, in 2011 Freeport replaced 90% of the mined product with new reserves. The bottom line is that this is a well-run miner with world-class reserves in copper, gold and molybdium that has the income at present metal prices to grow shareholder value.

We see FCX as a reasonable long-term play both on copper and gold. However, given the technical situation at the present time, traders may want to take a flyer on the May 40 call for about $1.15 each.

Revett Minerals Inc. (RVM) - Revett Minerals owns the Troy mine in Montana, which last year produced 1.3MM ounces of silver and 10.6MM pounds of copper. Their mining operation yields a cost of $2.22 per pound of copper. Some 24% of their planned 2012 copper production is sold forward at $4 per pound, a little better than the current spot price. RVM also owns the Rock Creek property in Montana, this country's largest undeveloped silver/copper deposit, and one of the ten largest silver deposits in the world. This stock was featured in my article, My Affair with Silver..., and I have liked this as a silver miner for some time. Nevertheless, the company derives about half its revenue from copper, so a boost in the copper price would provide a bungee effect to its earnings.

Last week, RVM reported net income of $.36 per share for 2011, giving the stock a PE of less than 12. The cash flow from operations is averaging about $1 per year, and it is debt free. Revett's market capital is about 2 times sales and 2 times book value, so by all value metrics it passes the test.

From a technical perspective, the stock is now selling at almost precisely the point where it gapped up from $4.22 to $5.90 on the day RVM announced the final decision against environmental complaints blocking the Rock Creek development. Having filled the gap, it should be poised for appreciation. Any price increase in copper will add to the recent income boost from silver sales.

Orvana Minerals (ORVMF.PK) is a multi-mine gold and copper producer. Its primary asset is the El Valle-Boinas/Carles gold-copper mine in Northern Spain, which went into production in 2011. Orvana also owns the Don Mario mine in Brazil and the Copperwood property in Michigan. This is an interesting risk/reward speculative play on copper.

Orvana began production of gold, copper and silver from its mine in Spain only in June 2011, and the fiscal year ends in September 31. The company recently reported first quarter 2012 results and the production was gaining momentum, but it still operated at a loss. It appears the next quarter is likely to be the first profitable quarter in the company's history. The mine in Bolivia is in a commissioning stage, but the complex mineral content has made commercial production difficult. Partly due to the Bolivia delays, the stock has dropped steadily from close to $4 per share to its current level of $.88.

The cost of production in the mine in Spain has been dropping, and the analysts following this company expect the EPS in 2012 to reach about $.14, and $.20 in 2013. After that the EPS should grow to more than $.30 per share. The company's projections would equate to better return than those numbers, but I am skeptical that the Boilivian venture will meet expectations, and I prefer to discount any earnings contribution from that mine. Even without that production, the profits seem to justify at least a $2 share price. Analysts have a 12 month target of $3.44.

The Copperwood property is expected to produce about 28,000 tons of copper annually for 13 years according to estimates. That amounts to $200MM in revenues and $120MM in profit annually, or about $1 per share. The problem is that it will require more than $200MM in capital expenditures to get that mine into operation, and it is not likely that Orvana can make that happen without a partner. However, with a sustained gain in the price of copper, this property or the company itself may become a takeover target. It has debt, but the current stock price is below book value.

Coleman Cable, Inc. (CCIX) is a copper cable manufacturer whose stock doubled from April to July of 2011 as the price of copper climbed steadily. Falling copper prices left the company sitting on higher-cost inventory, having to sell it at a lower price. As a result the stock price has dropped despite strong growth in revenues. The company can also sell cable for higher prices, and higher margins, in the market place as copper prices rise. This has become a play on the spot copper price. The reverse inventory situation will occur if prices rise, and they can sell the cheaper inventory.

CCIX is well-priced with sales that are five times the market cap and a PE of less than 10. Their innovative products are expected to continue to provide revenue growth in the foreseeable future, and prospects for its customers in the electronics, telecommunication and construction industries should improve in the growing economy.

While the ownership of gold and silver is considered a hedge against the negative effects of a bad economy, copper is a better indicator of an active economy. Today, as I write this the price of copper is up nearly 3% on positive manufacturing news. If the economy can continue the slow grind upward, the strain on an under-supply of the red metal can create a special opportunity regardless of the direction of the precious metals.

Disclosure: I am long CCIX.