Buy This Copper Producer on Lack of New Discoveries

With questions regarding China's demand, most commodities collapsed in the last year but copper prices have held up relatively well. A couple of factors have contributed to the resilient prices of copper outside of the supply situation at the LME. For one, China's demand continues to grow at 10% per year while the country accounts for 40% of the global demand. The other is that new copper deposits haven't been found in decades.

So while copper inventories in China and the LME have remained high over the last year, copper prices have maintained a strong stance above $3 per lb.One of the main reasons is that regardless of inventories, copper remains one of the most difficult commodities to mine and find new supplies. This leads to a long-term thesis of investing in copper producers such as global leader Freeport-McMoRan Copper & Gold (NYSE: FCX  ) (NYSE: FCX  ) (NYSE: FCX  ) or Southern Copper (NYSE: SCCO  ) (NYSE: SCCO  ) (NYSE: SCCO  ) . The interesting part about investing in copper is that it's just about as difficult to find a copper stock, as it is to find the commodity in the ground.

Another possibility is to invest in the iPath DJ-UBS Copper ETN (NYSEMKT: JJC  ) (NYSEMKT: JJC  ) (NYSEMKT: JJC  ) , which reflects the price of the copper high grade futures contract that trades on COMEX.

Lack of new supplies
Regardless of the current inventory position, copper remains one of the most difficult base metals to discover and mine. While demand remains strong in China, the weak housing market in the U.S. has led to weak global demand. If the U.S. were to show a dramatic increase in demand, the copper market would surge. When the U.S. last saw strong demand in 2006, China was a fraction of what it is now.

As opposite of oil and gas where new supplies are discovered regularly, copper remains a relic of past finds. The latest major discovery was Grasberg in 1988 or 25 years ago. Prior to that it was Escondia in 1979 or nearly 35 years ago. The below slide from the Freeport-McMoRan investor presentation highlights the limited discoveries in the last few decades:

Source: 2Q Conference Call

Freeport or Southern Copper?
The major issue with investing in copper is that limited options exist outside of Freeport or Southern Copper and both have drawbacks. Freeport has always been the major proxy for copper until it recently purchased significant assets in the oil and gas industry. It still remains primarily a copper play with over 50% of revenue from copper products.

Freeport operates 13 mines all around the world with production in North America, South America, Africa, and Indonesia. The company listed its second-quarter net cash cost of producing copper at $1.85 per pound, a level significantly higher than the $1.49 per pound from the prior year due to the issues surrounding casualties in Indonesia that shut down the operation for up to six weeks.

Southern Copper remains a difficult investment theory with the 81.5% ownership by Grupo Mexico, a Mexican company listed on the Mexican stock exchange. Though Southern Copper is based in Phoenix, it isn't as transparent as Freeport, and it remains a smaller competitor with plans to expand to 1,175,000 tons by 2017. Conversely, Freeport expects to expand beyond 5 million tons by that time frame.

Southern Copper operates ten facilities in Mexico and three in Peru with a primary focus on copper. During its second quarter, the company listed a copper cash cost of $1.30 per pound. Though the amount has moved upwards due to rising costs, the company has one of the lowest costs in the industry.

ETN?
The iPath copper ETN is designed to mimic the price of copper so an investor would need to choose whether to invest in the commodity or the miner. While a lot of investors prefer the commodity since it reduces the risk of subpar performance from a miner or government seizing of assets, an ETN or ETF doesn't provide the ability to produce profits or grow.

The ETN only has a listed asset base of nearly $100 million so it isn't widely held or followed. Over the last year, the ETN is down only about half the 20% loss of Freeport. An ETN provides an excellent alternative to the risk of an individual stock.

Bottom line
The lack of new discoveries of copper make the major miners of the commodity very attractive. Though Southern Copper has higher margins, Freeport remains the more transparent stock and the proxy for copper in the U.S. The ownership of Southern Copper by Grupo Mexico makes the stock less attractive, not to mention it trades at a higher earnings multiple. Even with the new oil and gas business, Freeport remains a great way to play the long-term demand for copper and the lack of new discoveries.

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  • Report this Comment On September 16, 2013, at 12:52 PM, ScottCherf wrote:

    Mark, it seems your long term case for copper miners is based on scarcity, which is good except that copper, as a long term material used primarily as an electrical conductor, doesn't have a future. Absent technical developments your strategy would be sound, but there are strong signs of developments that will put copper out of business as the conductor of choice.

    Superior conductors based on carbon have already been developed and they aren't just a little bit better than copper, they're literally orders of magnitude better. Agreed, these materials are still too expensive to produce, making them non-contenders in the short term, but I'll go out on a limb and assume you're taking a long view on copper. I'll suggest there's significant risk in that approach.

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