You Can Profit From Rock, Paper, Scissors

If the global economy is a giant game of “rock, paper, scissors,” then someone needs to stop throwing paper to an awaiting pair of scissors. It's time to crush those shears with some hard assets: rock and metal.

The present crisis is primarily one of leveraged paper assets losing their value, but commodity equities have thus far been catapulted from hedge funds and individual portfolios with the same undiscerning intensity. I cannot suggest a time frame for when rational behavior and valuations will regain sway over the equity markets, but I feel strongly that when that moment arrives, commodity equities will represent some of the very best long-term investment opportunities out there. For the cautious investor with some cash on the sidelines, the time to consider building such positions gradually may already be here.

In search of some of the zaniest valuations among the metals miners, I looked to the collective wisdom of the Motley Fool CAPS community of investors like you, seeking the five best-loved companies that have fallen the furthest from their respective highs. Using the Motley Fool CAPS stock screener tool, I limited the search to those companies not highly leveraged with debt, since those companies are arguably less likely to feel the weight of the credit crunch. The full criteria for this stock screen were as follows:

  • CAPS rating of at least four out of five stars (the highest).
  • Sector: Basic Materials; Industry: Metals & Mining.
  • At least 2,000 outperform picks from CAPS members, and 300 from All-Stars.
  • Shares trading at least 50% below their respective 52-week highs.
  • Long-term debt-to-equity ratio of not more than 0.60.

Company

Total / All-Star Outperform Calls

% Below 52-Week High

LT Debt-to-Equity Ratio

Aluminum Corporation of China (NYSE: ACH  )

3,317 / 510

87.9%

0.26

BHP Billiton (NYSE: BHP  )

2,332 / 427

61.0%

0.38

Freeport-McMoRan Copper & Gold (NYSE: FCX  )

4,378 / 632

71.4%

0.45

Southern Copper (NYSE: PCU  )

3,807 / 628

76.2%

0.32

Yamana Gold (NYSE: AUY  )

3,033 / 422

72.2%

0.08

Data from Motley Fool CAPS as of Oct. 10, 2008.

The falling red metal
Perhaps it’s no coincidence that four of the five miners listed above have some significant exposure to copper. With widespread uncertainty over the revised forecast for economic growth from the BRIC countries (Brazil, Russia, India, China) that so famously fueled the bull market for commodities, copper miners have been tossed out the window as though they mined paper assets like mortgage-backed securities or toxic OTC derivatives.

Copper futures have fallen sharply, dropping 40% from their highs above $4 earlier this year to just over $2.40 today. Nonetheless, by looking at a long-term chart, we see that copper remains well above its historical range. Just as we've seen with gold miners like Yamana and Gold Fields (NYSE: GFI  ) , these equities have fallen much further than the price of the underlying commodity.

CAPS All-Star InvestRx sees deep value in Freeport-McMoRan:

[Freeport] is a good example of a value play (trading at less than 5X forward earnings) resulting from the broad-based sell-off in commodities and forced hedge fund liquidation. The stock has broke below the $40 level on this week's market sell-off, resulting in a dividend yield over 5%. This is my favorite pick as a leveraged, high beta play on the eventual market recovery.

With significant gold production to offset weakness in the copper market, combined with the company's continued attractiveness as a potential acquisition target, I think InvestRx is onto something here. Freeport's long-term debt-to-equity ratio is near the high end of the criteria listed above, but value-loving Fools recognize that in a capital-intensive industry like mining, that 0.45 ratio is the sign of a conservatively leveraged outfit amid a global credit crunch. Freeport's $1.65 billion in cash on hand at the close of the second quarter, though nowhere near the $4.24 billion reported by BHP Billiton, will help see the company through trying times.

China is still there
CAPS All-Star PaddingFool reminds fellow Fools that China still has some growth in its future, and that Southern Copper's 18% dividend makes it a particularly attractive option:

At these levels the price suggests the use of copper has stopped. This isn't the case! Copper continues to be an important material and its continued use is guaranteed. China is still a huge user and the current price is a bargain for this company. And don't forget that dividend!

Although Fools must keep an eye on a fresh round of unrest among miners in Peru, and a dividend that high may be adjusted during tough times like these, I continue to like the long-term prospects for this company and the copper sector at large.

For a small-cap miner with one impressive copper deposit, Fools might take a fresh look at Taseko Mines (AMEX: TGB  ) . When the panic clears, I believe these miners will lead a commodity resurgence.

In the coming weeks, Fool co-founder David Gardner and his Motley Fool Pro team will invest $1 million in a portfolio designed to help you make money in any market. The service, which just launched, will rely heavily on proprietary CAPS “community intelligence” data to establish long and short positions in a broad range of securities, including common stocks, publicly traded put and call options, and exchange-traded funds. To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.

Fool contributor Christopher Barker captains yachts and writes about stocks. He can also be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Aluminum Corporation of China, BHP Billiton, Freeport-McMoRan, Gold Fields, Taseko Mines, and Yamana Gold. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 14, 2008, at 4:19 PM, doubleDownDave wrote:

    I believe that Southern Copper (PCU) has the price they will receive for their copper set at a fixed range for the time period approximately March 2008 thru March 2009. Someone may want to check on this to make sure.

    If this is true, then their revenues going forward through this period should be pretty well set, assuming their production in pounds comes in as forecasted. Thus, in turn, a tight range for their net income should be readily estimated.

    This is why I'm surprised that their stock price was hammered so badly and why it seems like a good bet that the stock price should rebound in the next six to nine months.

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