Cashing In on Copper

Driven by the overall strength of the global economy over the past few years and voracious demand from developing nations, copper prices have enjoyed a stellar run. They have jumped 446% since 2002, from an average of $0.72 per pound to today's $3.93 per pound.

Will the possibility of a recession in the U.S. and the turmoil gripping today's credit markets change that trend? Call me a Fool, but I think that's unlikely. Continued robust demand from China and India -- coupled with supply constraints -- will keep the red metal "red hot" in 2008 and beyond.

Ways to play
Now, there are many ways to play the continued strength in copper, ranging from U.S.-based Freeport-McMoRan (NYSE: FCX  ) to the diversified mining giants like BHP Billiton (NYSE: BHP  ) and Rio Tinto (NYSE: RTP  ) . My favorite company in the sector, though, is Southern Copper (NYSE: PCU  ) .

Simply put, I like Southern Copper because it holds the largest amount of copper reserves of any publicly traded corporation and should continue to benefit from robust global demand for the red metal. Furthermore, the company's tight focus on copper allows it to translate any incremental increase in prices into significant earnings growth. Meanwhile, the shares  offer a 4.7% dividend yield.

Let's dig a little deeper, shall we?

Supply and demand
China's economy just recorded GDP growth of 10.6% in the first quarter of 2008, and the country's continued economic strength is expected to increase Chinese copper demand by 10% to 15% in 2008. Similarly, the Indian economy is estimated to grow by 8.1% to 8.6% in 2008, while copper consumption is expected to increase by 9.5% both this year and next.

I know, I know ... demand is only one part of the equation. However, supply also looks tight. UBS recently upped its copper price forecasts for 2008 and 2009 sharply, citing concerns about labor strikes in Chile (the world's largest copper producer), the likelihood of disappointing production efforts in Africa's "Copperbelt," and low inventory levels.

More digging
Southern Copper, majority-owned by Grupo Mexico, owned and operated nine copper mines in Mexico and Peru in 2007 that produced around 1.3 billion pounds of copper, 267 million pounds of zinc, 36 million pounds of molybdenum, and 15.2 million ounces of silver.

The copper, zinc, and silver totals represented a decrease from the amounts produced in 2006, but let me hasten to point out that the decline was the result of a labor strike at three of its Mexican mines, including its large Cananea operation. Resuming full operations at these mines should enable Southern Copper to realize the increasing prices for copper and its associated by-products.

As I mentioned above, copper prices are expected to stay strong in both 2008 and 2009 due to robust demand and tight supplies. The company estimates that, based on 2006 production levels, for every $0.01 increase in the price of copper per pound, the company pulls in an additional $12.4 million in operating income.

Furthermore, the by-products of the company's copper mining process -- molybdenum and silver among them -- have also risen in price dramatically. Let's also not forget the $2.1 billion expansion plan announced by management, which will increase Southern Copper's annual copper production capacity by 270,000 tons, or 39%, by 2011.

The big dig
Southern Copper is well positioned to benefit from its large copper reserves, rising prices, the resolution to the labor strikes in Mexico, and an increase in production capacity. At a recent price of $122 a share, the pure-play copper producer trades at roughly 13 times analysts' 2008 estimates of $8.87; estimates that I find conservative given the factors mentioned above.

With the potential upside to earnings expectations, as well as the comfort of a juicy dividend, I'd urge investors to give Southern Copper a closer look.

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