Copper Bull Market

Scott Wright, Zeal LLC
Sep 30, 2005

Nearly five years into this commodities bull market, commodities today are finally starting to garner mainstream attention. Global economic expansion, natural disasters and market valuations are piquing commodity interest not only for investors and speculators, but the mass public. People are finally starting to understand the importance of natural resources in their everyday lives, and now is when it really gets exciting for investors and speculators.

As the commodities bull of the 00's races on, our investment focus at Zeal has centered on stocks leveraged to capture the greatest gains relative to the price appreciation of the underlying commodity they produce. Gold, silver and oil are our usual suspects and typically get the most face-time for obvious reasons.

Gold and silver are timeless, alluring and enduring precious metals in which their beauty, rarity and store of value captivate many. And oil is such an economically valuable natural resource in today's global economy it affects virtually every person on the planet in one way or another. These are just a few of the many fundamental reasons for this focus, but from an investment perspective it all hinges on the fact that they are easy to invest in. Gold, silver and oil are among a handful of commodities in which the majority of their producers trade in the public stock markets.

Quite unfortunately for pure stock investors, most commodities trade solely on the futures markets. You would be hard-pressed to find publicly traded companies that are able to leverage the price of say soy beans, corn, cotton and hogs. Most investors, understandably so, simply lack the proficiency, desire and capital to trade effectively in the futures markets.

For many investors just the mention of the word "futures" makes them shudder in fear. If one fiddles around in the futures markets and does not understand what they are doing, they can get slaughtered. Though there are differing opinions as to which is more risky between futures trading and stock trading, if you know how to play your cards right in this commodities bull either venue offers the potential to capture legendary gains.

Futures trader or not, it is important to understand that commodities are more than just precious metals and energy sources. As investors and speculators we typically stay focused on specific areas of interest or popularity, but occasionally we need to take a look outside the box. The markets continually prove they are not biased, and have historically shown that any natural resource experiencing an economic imbalance can be financially exploited.

Today we are witnessing major economic imbalances in a myriad of commodities, and as this commodities bull picks up steam, various commodities in addition to the usual suspects have and will give stock investors opportunities to multiply their capital. While stock investors are not able to take advantage of every commodity, there are several out there that do warrant a look.

A few months ago we took a look at uranium as one of these commodities and found there to be ample opportunity for stock investors to take advantage of its continuing bull run. Like uranium and most general commodities, copper is in a secular bull market of its own. Today we will take a top-down look at copper and see if further opportunities exist for today's stock investors.

Though copper is neither a precious metal nor a source of energy, it boasts indispensable industrial, technological and economic uses and is one of the most important nonferrous commodities today. In addition to its economic significance, it has had quite a run thus far in today's commodities bull market.

As you can see in our chart below, copper prices have soared in the last four years with all-time highs being achieved this week. Those companies that produce and sell copper have watched their revenues and profits skyrocket in this time, and have consequentially provided their shareholders with very handsome gains.

Our dual-axis chart shows the secular trend that general commodities, represented through the CRB Commodities Index, have had since 2001. In addition to the CRB, the price of copper is charted over this same time period represented in dollars-per-pound as it trades on the COMEX. It is readily apparent that the two trends are marching in unison to the tune of a secular bull market with the CRB rising over 80% since late 2001 and copper shooting up over 200% in this same time period.

In the 1980s and 1990s commodities were beaten and battered. Inventories were full, mines and drills were shut down or had their production slowed and for all consumption purposes, commodities were cheap and easy to get. Aside from the occasional bear-market rally, from an investor's standpoint commodities were the dogs of the markets.

Well, times have changed and the global economy is growing at a fast and furious pace led by the super-economies of China and India. Commodities that were once undervalued are now starting to rise in price due to the simple economic imbalance of supply and demand. Industrial development and growth in manufacturing and high technology have kicked up demand for the various natural resources used in their production, hence causing global inventories of recent to sharply decline in order to keep up with this new-found demand.

Copper falls comfortably into this cycle and China's voracious appetite for this metal has been an underlying catalyst to increased global demand and has almost single-handedly emptied warehouses, drastically decreasing worldwide stock levels.

For example, in July of this year, copper stocks at the London Metals Exchange (LME) hit 31-year lows of 25,550 tons, which has the equivalency of less than two days of global consumption. The hundreds of warehouses around the world, most commissioned and approved by the major metal exchanges (LME, COMEX, SHFE), have seen their inventories hit dangerously low levels. There have even been reports of many producers bypassing the warehouses and shipping directly to the countries or organizations in need of the metal.

China's demand for copper has hit such extremes that in 2002 it created a large state-owned enterprise in order to exploit the international development of nonferrous metals, mainly copper. The firm is called China Nonferrous Metal Mining & Construction Co., Ltd. (CNMC). Three years later CNMC has operations in over 30 different countries and is aggressively feeding its smelters back home.

Upon CNMC's creation, Zhang Jian, general manager of China Nonferrous Metal Industry's Foreign Engineering and Construction Group Company (CNFC) said, "It is of strategic significance to China's economic development to set up a long-term and stable overseas mineral resources supply base. However many domestic small-scale nonferrous companies are incapable of solely tapping mines abroad. The only way is to jointly exploit overseas mineral resources."

With China as well as many other growing economies drawing down global inventories, it becomes clear why copper prices are on the rise and why there is currently a copper deficit. Case in point, according to the International Copper Study Group, even though world mine production of copper in 2004 rose by 900,000 tons (6.6%), it was estimated that there was still a global copper production deficit of up to 700,000 tons.

Now in order to help us decide how to play this bull run in copper, we need to take a closer fundamental look at copper itself in order to help us understand its economic impact. First and most important, just like any other metal pulled from the ground, copper is dependent on miners to ultimately provide the supply. Even though copper has an excellent capacity for recycling, at the end of the day mined output is what puts the ingots on the shelves.

In order to keep up with today's and tomorrow's copper demand, mined output will need to increase. Unfortunately, increasing mine production is not as easy as turning a faucet counter-clockwise. As is with all metals, ramping up production and opening up new mines requires significant time and capital. It is during that time, or cycle, that investors have the opportunity to take advantage of rising prices.

Now even though the economic imbalance of copper is prevalent today, we need to keep in mind that copper does not have the same economic fundamentals as precious metals. Copper, said to be the first metal known to man, is not a store of value like gold and silver. Even though many of today's global fiat currencies are circulated in copper, it is not valuable in this sense. Copper or copper-alloyed coins are common because it is a cheap metal and there has historically been an abundance of it.

The biggest differences between copper and precious metals, especially gold and silver, are the rarity and store of value factors. According to the Copper Development Association (CDA) of the USA, it is estimated that global copper resources are nearly 6 trillion pounds. The CDA also estimates that throughout history only 700 billion pounds of copper have been mined.

These massive reserves and resources coupled with copper's high recycle rate show there to be no imminent risk of ever running out. So for copper it is not an issue of rarity or store of value, it is a matter of ramping up supply to meet demand. Just like all commodities, until this happens market forces will adjust the prices accordingly in the upwards direction and give investors the opportunity to go long and profit.

Though copper has no store of value, its innumerable industrial uses are absolutely invaluable. During the tech boom of the 1990s copper got a bad rap due to the push for fiber optics, which were perceived as the replacement for copper wires in telecommunications. Although this did reduce demand from that sector and contributed to its lowest prices in nearly 25 years, this malleable and ductile metal continues to prove its resiliency and usefulness in virtually every economic sector. It is used heavily in building construction, transportation, electrical, automotive and still telecommunications among many other major industries.

According to the CDA, building construction accounts for 46% of all copper use in America with the average single-family home using 440 pounds of copper. This tells a story in itself as today we are witnessing a global boom in residential and commercial infrastructure, yet another testament as to why global demand for copper has been on the rise.

The geopolitics of copper also play an important role in today's copper market. Chile happens to be the biggest player in the global copper market. More copper comes out of Chile than any other country in the world, by far. The Chilean Copper Commission (Cochilco) forecasts 5.5 million tons of copper production in 2005, about 0.1 million tons up from the previous year.

This amounts to more than one-third of all global mine production in 2004 as well as that of 2005 forecasts. Much of this copper is mined by state-owned firm Codelco, but a massive international presence is aggressively increasing its stake into the rich Chilean copper regions. The copper industry is so massive along the Pan American Highway, especially in Chile and Peru, that it has become the lifeblood of their economies.

Because the copper operations in Chile are so strategically voluminous, geopolitical events within its borders can have a significant effect on global copper prices. In June of this year, a 7.9 magnitude earthquake rattled Chile, causing various mining operations to be temporarily shut down or delayed.

Also this year were sizable strikes by Chilean mining employees that, though now resolved, temporarily hampered production and caused some uneasiness in the futures markets. Many analysts believe the earthquakes and strikes in Chile are what sustained and pushed higher copper prices this year out of fear that production would be seriously depressed, but according to Cochilco, those anomalies were insignificant in regard to annual production estimates.

According to the U.S. Geological Survey (USGS), United States copper production in 2004 was second highest to Chile at nearly 1.2 million tons with Chile's neighbor Peru close behind at 1.0 million tons. Interestingly, the top three copper producing countries in the world accounted for over 50% of global production in 2004, a trend expected to continue for years to come.

Reverting back to the chart above, notice the eight month period from mid-2003 to early 2004. Copper prices rose by a whopping 87% during that span. Some analysts attributed such a swift gain to a mining disaster at the Grasberg mine in Indonesia, the fourth largest copper-producing country in the world. Much hype was centered on this event as the Grasberg mine happens to be the largest gold mine and third largest copper mine in the world.

In October 2003 a rockslide at the Grasberg mine, which interestingly was built for a then-record price tag of $3 billion, killed several employees and slowed production for a period of time reducing its copper output to the market. Though unfortunate for those killed and hurt in this accident, production was soon after brought back up to speed and similar to the Chile turmoil this summer, copper prices were sustained and continued to shoot higher.

The anomalous events in Indonesia and Chile did not artificially inflate copper prices as analysts had feared. The upward trends were in force and it was becoming apparent that global inventories were dwindling and an economic imbalance was occurring. Until there is equilibrium in global supply and demand, copper prices will remain high and most likely move even higher.

Now as stock investors, how can we take advantage of the copper bull market and leverage some of our capital? Well just like our usual suspects of gold, silver and oil, we trade the stocks of its producers. Fortunately there are quite a few copper producers that are publicly traded in the stock markets.

Just like most metal producers, copper producers are highly leveraged to the fluctuation of the underlying metal price. For all intents and purposes, their operating expenses remain the same in pulling the copper from the ground regardless of the price they can sell it for. The higher the price they are able get on the open market, the higher their profits. In the last couple of years copper producers have been making barrels of money as prices have risen, and to this point their stock prices have reflected such.

Since 2001, the top four copper producers trading on the American stock exchanges have averaged bull-to-date gains in excess of 450%, with some of the smaller miners doing just as well if not better. As copper prices continue to rise, so will the stock market gains of its producers.

In addition to their leverage to the price of copper, copper producing companies have further benefits that help their bottom-line in this commodities bull market. When copper is mined, the ore it comes from usually contains precious-metal byproducts.

Many large copper mines around the world have significant amounts of gold and silver byproducts in their ores. From an accounting standpoint they will either book it as separate revenue or bundle it with their copper using the PM revenue to reduce the overall operating expenses of their copper. Either way, with the performance of gold and silver thus far, it proves to be a major boost to these companies' profits.

There are two key ingredients that go into choosing the companies in which to invest your hard-earned capital. First is timing, and second are the fundamentals of the individual companies. Both of these ingredients take much time and research.

Timing the deployment of capital involves analyzing the fundamental and technical trends of the copper market. If you are trading for the long term then it is simplest to buy on the dips and ride out the copper bull. If you are more of a short-term or momentum player, then a little bit more goes into your entry and exit points.

Picking the individual companies that are best positioned to leverage the price of copper involves legwork as well. Of course there are always the biggest and best blue-chip producers, but opportunities also abound in the intermediate and smaller miners and explorers. Like the gold market, extreme caution and prudence need to be taken in choosing these smaller companies.

All signs point towards the probability of a continued bull run in copper in the years to come. At Zeal we are diligently researching investment and speculation opportunities for our newsletter subscribers in order to take advantage of current market conditions.

Please subscribe today and ride this commodities bull with us as we provide our subscribers with cutting-edge analysis and stock picks not only for the copper market, but gold, silver, oil and many other commodities that stock investors crave.

The bottom line is this reddish metal we call copper continues to show future promise in this exciting secular bull market. Global inventories are down and demand is up as the world economy grows.

Whereas in the 1980s and 1990s commodities producers, including copper, were the black plague of stock investing, today's commodities bull presents a high probability of bringing legendary gains to prudent investors and speculators.

Scott Wright
[Adam Hamilton's partner at ZEAL]
Sep 30, 2005

So how can you profit from this information?  We publish a monthly newsletter, Zeal Intelligence, that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month at www.zealllc.com/subscribe.htm.

Thoughts, comments, or flames?  Fire away at scottq@zealllc.com. Depending on the volume of feedback I may not have time to respond personally, but I will read all messages. Thanks!

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