Mining industry titans Freeport-McMoRan (NYSE:FCX) and Barrick Gold (NYSE:GOLD) have had their share of troubles over the years. Excessive debt brought on by overzealous expansion during the boom years came back to bite both companies when commodity prices crashed. However, they have worked hard to address their issues by jettisoning non-core assets and reducing costs, which has resulted in significant improvements in both their balance sheets and cash flow. Consequently, each generates gobs of free cash flow these days even though copper and gold prices are nowhere near their former peaks.
That said, while both companies made noticeable progress in their turnaround efforts, the decision to buy one over the other boils down an investor's view on where the price of the main commodity they produce is heading. That's important because while both dig up gold and copper, Freeport-McMoRan is the largest publicly traded producer of the latter while Barrick Gold is the leading miner of the former. Understanding that distinction is crucial because of what appears to be on the horizon in the copper market since Freeport's focus on this market could send its profits and stock price soaring in the coming years.
The case for gold
Unlike most commodities, industrial demand isn't the primary driver of gold. That's because about half of the gold mined each year gets turned into jewelry while another 35% is either bought by central banks for reserves or held by investors. That latter use is important to note because it's the primary driver of pricing since investors buy gold as a hedge against inflation and currency risk. So, when those worries fall, so does the price of gold, which implies that speculation is the force that drives the gold market instead of the fundamentals of supply and demand.
The problem with this is that it's impossible to predict when speculation will heat up or dry up, which causes the price of gold to be quite volatile. For example, several factors could have a major impact on gold prices this year, including Federal Reserve monetary policy changes, inflation, and political uncertainty. While those factors could push gold prices higher and take Barrick Gold's stock up with it, they also might not come to fruition, which would deflate the price of gold. In other words, investing in gold or a gold mining stock is a gamble that market fears will spike.
The case for copper
Copper, on the other hand, moves on market fundamentals. And, right now, "the market fundamentals remain solid" according to comments by Freeport-McMoRan CEO Richard Adkerson on the company's most recent quarterly conference call. He noted that Chinese demand is better than most expected while European demand is improving and North America is growing at a slow rate.
Meanwhile, the longer-term outlook is even brighter. According to a forecast by industry experts at Wood Mackenzie, if copper demand grows at a modest pace of 1% per year, the industry will need to add 5 million tons of new supply to meet demand in the coming years. Given that new projects require copper at $3 an ounce to justify the investment, it suggests that copper prices will need to move higher so that the industry can meet demand. In the words of Adkerson, "there is a deficit looming, absent any big disruption in the world's economy or in China. There is an inevitable deficit that will allow our company to really profit from it." To put that potential into perspective, a $0.10-per-pound increase in the average copper price can boost the company's annual cash flow by $280 million. So, if copper were to rise to an average of more than $3 an ounce, its cash flow could jump from less than $4 billion to as much as $6 billion.
Either one is a gamble, but Freeport is the surer bet
Make no mistake about it, an investment in a focused mining company is taking a chance that the price of the commodity it pulls out of the ground will rise in the future. In the case of Barrick Gold, while it produces some copper, it's more of a bet that gold prices will rise on increased geopolitical or economic fears. Meanwhile, an investment in Freeport-McMoRan is a gamble that copper market fundamentals will tighten leading to higher prices for both copper and Freeport's stock since that's how it makes most of its money.
Given that distinction, and the increasing evidence suggesting that the copper market is on the upswing, Freeport appears to be the better stock to buy in my opinion.