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Someone must have held a giant torch to the global copper market. Otherwise, how are mere mortals to make sense of this complete meltdown in copper-related stocks over the past couple of months?
Since early August, copper prices have slipped 30% from about $4.50 per pound to $3.11. Copper mining stocks have proven to be a devastating choice for 2011, with even popular favorites Southern Copper (NYSE: SCCO ) and Freeport-McMoRan Copper & Gold (NYSE: FCX ) suffering declines on the order of 50% year-to-date! Most of that damage has come quite recently, corresponding to a horrendous 36% retreat for the Global X Copper Miners ETF (NYSE: COPX ) just since the end of August.
I wish I could say I saw this coming. I did not. In fact, I sounded the "all-clear" for copper miners back in May following a prior correction, and as a result my concurrent selection of the First Trust ISE Global Copper Index Fund (NYSE: CU ) for my Motley Fool CAPS portfolio has underperformed the S&P 500 Index (INDEX: ^GSPC) by more than 22%. Credit to my Foolish colleague Alex Dumortier, who expressed near-term concern for copper prices after reviewing commentary from analyst Simon Hunt. Hunt's view that "we could see prices rise to around 9500 and then begin falling to at least 7500 by October" has proven quite prophetic, as the per-tonne price recently breached $7,000.
What's melting these copper prices?
Contracting growth outlooks around the globe -- and in particular the growing concerns over a potential hard landing for China -- appear the most easily identifiable conductors of the metal's sudden weakness. But that's far from the whole story. In addition, persistent debt distress in European markets has fomented a noteworthy advance for the U.S. dollar index. In fact, as my colleague Sean Williams points out, the dollar has outperformed even silver year-to-date on the strength of its recent rally.
Given that powerful one-two punch, copper is obviously not crashing by itself. Rather, the full suite of industrial raw materials -- including steelmaking components iron ore and metallurgical coal -- have suffered in tandem. So after a decade of extraordinary price gains for copper and other key commodities, is this the end of the line for the broader commodities bull market? According to this Fool, certainly not! As was the case in 2008, when a far deeper correction blasted the sector and buried related equities miles below any rational notion of fair value, I maintain this latest event will likewise produce merely a volatile chapter within the long-term secular bull market for commodities … rather than a lasting reversal of the trend. That's not to say the current correction could not carve deeper still, since expectations for industrial demand around the world clearly remain fluid.
While there can be no doubt that a relative slowdown in China could send powerful waves of repercussions throughout the global economy, I find it extremely difficult to envision a scenario where China's demand for copper ceases to mount. Furthermore, nations around the world facing bleak economic conditions will likely turn to public investments in infrastructure for stimulative effect. Combining that baseline demand outlook with persistent constraints on global supply, I maintain we are still left with a sound fundamental framework for copper despite global growth concerns. Equipment manufacturer Joy Global (Nasdaq: JOYG ) is dialed-in to the global copper market, and offered this reassuring update to its market outlook at the end of August:
The seaborne markets for copper, coal and iron ore continue to be driven by strong demand from China, India and other emerging markets. Although industrial production and export growth is showing signs of slowing in China, massive infrastructure programs should sustain GDP growth at high levels. Imports were reduced as China worked down inventories of copper and coal in the first half of this year, but recent increases of imports have started to replenish these stocks. This move from de-stocking to restocking for copper and coal will support commodity demand even if growth slows.
As the macroeconomic outlook continues to dim, some taming of expectations for copper demand is wholly appropriate, but from my vantage point the recent sell-off in shares of quality copper producers smacks of a disconnect from resilient long-term fundamentals. What's more, when we consider that a single trader -- identified by The Daily Telegraph as none other than JPMorgan Chase (NYSE: JPM ) -- had cornered at least 50% of the entire copper supply of the London Metals Exchange by late 2010, I believe the copper market had grown structurally prone to occasional and volatile disconnects from underlying fundamentals.
The Foolish bottom line
At around $3 per pound, copper prices remain quite elevated from a historical perspective, and my ongoing analysis of the global supply pipeline combined with baseline demand expectations from China and emerging markets continues to support a long-term bullish outlook for copper and the low-cost miners that produce it. Frankly, notwithstanding the recent dollar rally, the long-term outlook for the U.S. dollar and other structurally strained currencies supports that case. Without daring to declare a bottom in this near-term sell-off, I cannot ignore the glaring valuations left in its path. Taseko Mines (AMEX: TGB ) stood out to me as a compelling value near $4.50 per share last June, so you can just imagine what I think of the valuation here beneath $2.70! Ivanhoe Mines (NYSE: IVN ) has fallen further than some as the Mongolian government expressed interest in revising the terms of its agreement regarding the world-class Oyu Tolgoi mine that is progressing toward commercial production during the first half of 2013. The mine is already Mongolia's cuprous meal-ticket, and I have every expectation the agreement will stand in its present form. [Author's note: a joint statement issued by the government of Mongolia, Ivanhoe Mines, and Rio Tinto on the date of this publication upholds the existing agreement.] These names stand out to me, but truthfully I find the entire sector remarkably undervalued here. As a result, I am effectively doubling down with my bullish bet on copper miners by adding the Global X Copper Miners ETF as a second sector ETF within my Motley Fool CAPS portfolio.