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An Insider's Take on the Copper Correction

By Matt Badiali, editor, S&A Resource Report
Wednesday, October 19, 2011

It's one of the most dramatic moves of 2011...
In just one month, copper – one of the world's most important building materials – fell 25% in price.
To get an "insider" perspective on the drop, I called Rick Rule, one of the world's most successful resource investors.
Rick isn't some ivory tower economist... far from it. He's a fund manager. But he prefers to call himself a pawnbroker. Successful pawnbrokers and resource investors both have to know when something is cheap enough to buy.
But before we know whether copper is cheap enough to buy, we have to understand why it fell in the first place...
The copper price fell because of a collapse in credit.
Smelters and fabricators, who buy the majority of copper, don't use petty cash to make the purchases. A bank lends them money. When the smelter sells the finished products, it pays off the loan.
Traditionally, European banks provided financing to the base metal industry. But as you may know, European banks are in deep trouble right now. The banks can't lend money they don't have. With no available credit, smelters can't buy copper. The lack of demand for copper sent the price plummeting.
This is a short-term issue.
We can't do without copper stuff for long. As my colleague Brian Hunt likes to say, copper is in everything: home wiring, plumbing, cars, electronics, refrigerators, you name it. Once the banking crisis eases, smelters will begin buying copper again and the spot price will rise.
In the meantime, other bank troubles could actually put a floor under copper prices. Right now, banks are unwilling to fund mine construction. (That's true for all the base metals, not just copper.) If the industry can't finance new mines, we will run into supply constraints down the road.
In short, this collapse in the copper price shouldn't go much farther. And I expect we'll see higher prices down the road.
But Rick isn't buying yet. He's anticipating some lower prices in the near future. "I'm waiting for a moment of absolute pessimism," he told me. "And that hasn't come yet."
Since its bottom early this month, copper has recovered more than 8%. And investors have jumped right back in. The sector will need to drain out some of that optimism before Rick begins to buy again.
When he does, he'll be looking at companies like Freeport-McMoRan, which I included in my "trophy list." As Rick explained, he likes to buy companies with the lowest cost of production. That way, if trouble hits, he owns the companies that will be the "last men standing." With a production cost of just $0.79 per pound of copper (about half the industry average and less than one-third of the current copper price) Freeport can remain standing through much worse.
Keep this idea on your watch list. Copper is capable of spectacular, tradable moves – both up and down. And the biggest gains are made when you can buy it very cheap. That moment may not be here yet... But when it comes, you'll want to own super-low-cost producers, like Freeport.
Good investing,
Matt Badiali

Further Reading:

Earlier this month, Matt wrote out a list of the biggest, brightest stars in the commodities universe for Growth Stock Wire readers. Each company on the list "owns a portfolio of the best assets in the industry," he writes. "When the market finally bottoms out, these are the companies I'm going to look at first." Find out which companies made the cut here: The List: What to Buy at the End of the World.
Frank Curzio recently checked in with Rick Rule on the S&A Investor Podcast. He and Rick spoke about huge opportunities in commodities and the future of precious metals prices. To access this podcast for free, click here.

In The Daily Crux
Market Notes
Silver is still the best-performing commodity over the past year... up 30%.
Tech giants Apple, Intel, and Cisco are all trading at or near three-month highs.
Shale gas giant Range Resources is sitting just below a fresh all-time high... up 98% over the past 12 months.
Ag giant Monsanto gains 10% over the past six months, despite declines in corn, wheat, and soybean prices.
Market Watch
Symbol Price
S&P 500 1225.38 +2.0% +3.4%
Oil (USO) 34.15 +2.2% -5.9%
Gold (GLD) 161.84 -0.5% +20.5%
Silver (SLV) 31.33 +0.9% +30.8%
U.S. Dollar 77.19 +0.8% +0.2%
Euro 1.38 +0.2% -1.4%
Volatility (^VIX) 31.56 -5.5% +65.3%
Gold Stocks (^HUI) 541.56 -2.6% +3.6%
10-Year Yield 2.15 -3.6% -16.7%

World ETFs
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Canada (EWC) 27.25 +1.6% -4.4%
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China (FXI) 34.14 +1.7% -24.8%
India (IFN) 24.41 +0.6% -27.4%

Sector ETFs
Symbol Price
Internet (HHH) 83.37 +0.7% +25.5%
Retail (PMR) 20.57 +1.9% +15.3%
Big Tech (QQQQ) 57.99 +1.2% +13.9%
Consumer Svcs (IYC) 69.76 +1.6% +12.4%
Utilities (XLU) 34.08 +0.7% +11.4%
Big Pharma (PPH) 66.99 +0.7% +4.9%
Health Care (IYH) 67.03 +0.6% +4.8%
Software (PSJ) 24.07 +1.7% +3.9%
Industrials (IYJ) 60.64 +2.7% +3.1%
Oil Service (OIH) 121.07 +3.7% +2.9%
Media (PBS) 13.07 +2.0% +1.8%
Semis (PSI) 13.76 +2.2% +1.2%
Real Estate (IYR) 53.14 +3.3% +0.9%
Transportation (IYT) 84.19 +2.9% +0.6%
Defense (PPA) 17.62 +2.0% +0.4%
Telecom (IYZ) 21.22 +1.3% -0.4%
Construction (PKB) 11.15 +2.9% -3.2%
Biotech (PBE) 19.33 +0.8% -5.1%
Water (PHO) 16.39 +1.6% -5.5%
Basic Mat (IYM) 63.71 +2.5% -5.6%
Insurance (PIC) 14.25 +4.0% -7.7%
Financials (IYF) 47.59 +4.4% -9.5%
Nanotech (PXN) 6.19 +1.0% -35.7%
Alt. Energy (PBW) 5.85 +2.8% -42.3%

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