They say copper has a Ph.D. in Economics because it is so sensitive to economic activity. But, lately copper seems to have changed its qualification. It may be that it now has a Ph.D. In Chinndonesian economics, while giving up its prognostications on the dismal science regarding the West.
We see the same action in copper and oil as we see in junk bonds — they are rallying even as two-year note yields are falling.
It is easy to dismiss the U.S. Treasury market as a bubble and irrational, but it is huge — it is difficult to manipulate a big market. I am watching the action here with great interest because one of these indicators is about to be wrong.
In my book, I wrote a chapter on industrial metals — named appropriately “The Lure of the Mega Trend” — that was inspired by a fund manager who was always talking about megatrends, but consistently managed to mess things up so spectacularly that he almost surpassed T. Boone Pickens with his performance in 2008.
Since I don’t want to repeat what Boone or our megatrends manager did that year, here is the still-valid introduction from that chapter:
The idea is almost too simple to embrace.
When developing economies need to build their infrastructure to developed world standards, they need a lot of basic materials, or commodities. If those developing economies are small, such needs will not move commodity prices. But as developing economies reach critical mass — as have the economies of China and India — they will exercise greater and greater influence on those prices. Commodity markets today bear the weight of the rapidly expanding Chinese economy, and an increasing number of developing economies will join this competition for resources in coming years.
The simplicity ends here.
The current commodity cycle offers no license to print money, despite bullish long-term fundamentals. China has been growing at breakneck pace for 25 years. Any economic slowdown or policy error in China (or the U.S. for that matter) can cause serious shakeouts in the commodities markets. Though prospects may be bright, the long term is comprised of many short terms — if one mishandles several short terms, it may be very difficult to achieve long-term success.
Why the caveat emptor? Not all commodities are created equal. Some commodities are highly economically sensitive. Hard commodities (like metals) are directly correlated to economic activity worldwide. Soft commodities (like certain foods and grains) are a totally different story; affected by crop size, population growth, etc., they are much less economically sensitive.
The above was written in 2005 and published in March 2006 in my book, The Silk Road to Riches: How You Can Profit by Investing in Asia’s Newfound Prosperity.
Since then, the performance of copper, and other industrial metals illustrated my points on cyclicality well in 2008 and 2009. There was no policy error in China — there still isn’t — but there was huge one in the U.S.
The best-case scenario that I hope materializes is that the West holds together, while the East — namely Asia ex-Japan — keeps doing what it is doing and continues its rally (the Indian Sensex Index just hit a new 52-week high on Friday).
The major dedicated copper stocks available to investors in the U.S. are Freeport (NYSE: FCX) and Southern Copper (NYSE: SCCO). I like Southern as operations are concentrated in Mexico and Peru where the company has great political connections. Based on its reserve position and the increased demand for copper from industrializing nations, SCCO is the clear choice.
Recently, the company slowed down spending plans and is ramping up production in places that require less capital. With Chinese demand likely to remain robust — we are looking for a soft landing in China — and the global recession over, this is an operationally-leveraged copper producer that makes sense. Plus, it has better reserves than Freeport. But I would look to buy SCCO under $30 as the stocks zips in $10 point moves and is currently a little overdone to the upside.
Smaller, promising copper mines like Ivanhoe Mines (NYSE: IVN) are not attractive at present because they tend to correct more than producing mines on any pullbacks in copper prices. Speculative names that own big deposits like Ivanhoe, but do not produce much yet — whether copper, gold or zinc mines — should be approached near the beginning of a rally when they are “bombed out.” Currently, the stock trades at 7.8 times book value and can be bought at much cheaper prices, in my opinion.
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