|
Commodity bulls fall in 2 camps. One is the Jim Rogers camp which believe every “thing” is going up. This includes gold, silver, oil, copper, coffee, corn and even the paper the federal reserve notes are printed on (which could hasten the speed at which the notes are worth less than the paper they are printed on). The other camp believes that our current system will collapse as fiat money system reaches a painful climax leaving only gold , silver and perhaps oil worth anything in real terms. This camp believes that we are on the verge of a painful recession which will reduce demand for copper. For the purpose of this discussion we will lump the “housing bubble” and “peak oil” guys in here. Many prominent thinkers (including if I understand his comments correctly, Dr Marc Faber) are in this camp. I must admit that I am skeptical of the current copper prices. But the current global expansionary forces have a lot of traction. A housing bust in the US will be followed by the biggest liquidity surge ever. Just ask Helicopter Ben. Besides, US is no longer the only engine of world growth in this expansion. As China and India develop and utilize copper to modernize their cities they should more than compensate for any temporary slowdown here. Supply side looks equally if not more bullish. Rich copper veins are being depleted faster than they can be replaced. Copper companies are still assessing profitability at $1.00 a pound and low quality deposits are not being developed. Higher energy and material costs with the lack of rich deposits and increased shareholder demand for buybacks and dividends have created a perfect bullish storm for copper. Mind you, I am talking a few years out as I have no clue how the current correction will play out. The current market though is dominated by fear. At least as far as copper stocks are concerned. The valuations of copper stocks are proof. People have watched as Phelps Dodge thrashed the HUI 2:1 over the past three years. In spite of this Phelps Dodge trades at less than 1/5th the P/E ratio of HUI stocks and has distributed substantial dividends over the past three years. If the current prices hold Phelps Dodge will make over $17.00 a share this year giving it a P/E of 5. If that is not disbelief and fear I do not know what is. Assuming you are one of those in the camp that says we are going to hell in a handbasket I am going to make a suggestion to take advantage of this bull run that may be palatable. The current copper prices and the fantastic correction in commodity stocks has opened up some amazing resource opportunities. The market is in total disbelief and the valuations are very compelling. Companies with intelligent management teams are taking advantage. Let me give you an example. Yamana Gold (AUY) is a favorite junior gold play. Clearly most gold bulls can see the fundamentals there. Examining the company’s production profile one finds that approximately 180 million pounds of copper are going to be dug up in 2008. Most investors ( well most speculators at least) do not look that far. But Yamana’s management has looked that far and seeing attractive prices on the forward copper curve have hedged 90 million pounds at $2.75/ pound. http://www.yamana.com/ir/press/5242006-1.pdf Additionally they have purchased call options with a strike price of $3.25. This a bit different method of hedging than buying put options (which limit the downside), or buying puts and selling calls ( which limits both upside and downside). The way this works is that between copper prices of $0 and $3.25/pound Yamana gets $2.75/pound. At prices over $3.25/pound Yamana’s call options kick in which maintains upside exposure. So if prices were to average $4.00 in 2008 Yamana would make $3.50/pound. If prices average $10.00/ pound in 2008 Yamana would make $9.50/pound. Finally, if copper averaged $1.00/pound Yamana would make $2.75/pound. This is an unusual and more expensive method of hedging but one which I think personally makes a lot of sense. After expenses and taxes Yamana would make more than $150 million just on the hedged copper. If Yamana hedged all of their copper production they would have a P/E less than10 in 2008 just on their copper production! That is assuming copper prices come down a tad in the future. I am not going to mention the 800,000 ounces of Gold they should be producing by then. The copper production alone justifies the current market cap if copper prices stay over $2.00/pound over the next 5 years. Juniors gold companies like Yamana are in my opinion the best way to play the copper bull market. The hedge of Gold, a smart management team which limits downside exposure while maintaining upside should the unthinkable happen, and cheap valuations. There are a couple more out there but we will leave those for another day. I own shares in Yamana Gold. I have not been paid to write this article. Please consult your investment advisor before making any investment decision.
CONTACT
INFORMATION The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
