A Decline Coming for Copper and Copper Miners?
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Copper is one of the world's most important metals. It serves as a general indicator of the world's economic health. Surprisingly the metal has stayed relatively strong over the past year. This could be interpreted as underlying strength in the world economy or a lagging indicator which does not reflect reality. Other indicators of the world economy are not so positive. China's growth rate is decreasing and Europe is still mired in low growth. Given that China has become the world's factory its decreasing growth rate is of the up most importance for copper. There are a few positive forecasts for copper and with the advent of the latest round of quantitative easing more are taking a bullish position. I believe that once investors get into the numbers it becomes obvious that copper is set up for a negative or neutral situation for the coming years and investors should discount miners accordingly.
The bullish argument for copper is rather clear. The Fed's low rates until 2015, low copper inventories, and the continued industrialization in emerging market are said to be the main drivers of growth. The copper inventories appear to be somewhat deceptive. Although they are currently not at high levels this article points out that it is possible that a large amount of copper is being held outside of the warehouses and remains uncounted. The same article also states that many of China's copper imports are based one year contracts and thus are not completely related to the current economic situation. The latest developments in Chinese PMI are not very positive, world trade is not growing, and mine capacity utilization has declined over the past couple years. These factors detract from the argument that emerging markets will be able to maintain growth in the market. The Federal Reserve has held interest rates low for an extended period and yet world trade is collapsing and copper prices have not seen massive increases since 2010. The argument that the latest round of quantitative easing will be the salvation of copper is lacking. The price of copper has not moved to truly reflect the fundamentals.
As the first graph shows the price of copper does have a strong effect on miners. Stronger diversified miners like BHP Billiton Limited (NYSE: BHP) and Rio Tinto (NYSE: RIO) along with the smaller miners Southern Copper (NYSE: SCCO) and Freeport-McMoRan (NYSE: FCX) are all exposed to the metal. The profit margin of the Rio Tinto is the smallest of the group at 11.2% while the smaller producer Freeport McMoRan comes is only a few percentage points higher at 17.2%. BHP is one of the world's mining giant and has one of the highest profit margins at 21.3%. The smaller producer Southern Copper Corp has the highest profit margin at 34.7% but their less diversified operations do not give the same degree of security. As stated here during 2010 the FCX is the largest producer on a volume basis, followed by BHP Billiton, RIO, and then SCCO. When the price of copper falls, the profitability of the mines and the miners will decrease.
Executives of various copper producing corporations may lean on the positive side but investors are not obliged to do the same. World growth is still low, world trade has declined, and copper mine capacity utilization has declined. These factors point to short term and medium term difficulties. High margins will not hold up if copper prices return to 2009 levels and investors would be wise to revalue copper miners accordingly.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.