Freeport-McMoRan: Copper Continues to Drive This Stock
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Over the past several years, the appeal of Freeport-McMoRan Copper & Gold (NYSE: FCX) has been largely driven by the company’s exposure to the gold market. While gold continues to offer attractive prospects to investors, the increasing appeal of copper has become reason alone to own this stock.
While you should be mindful of the royalty renegotiations under way at the company’s largest copper mine in Indonesia, the impact of the royalty hike make take a full year to take effect. Ultimately, the combination of strengthening copper prices and a solid position for gold make Freeport a solid core holding.
The Trend in Copper
In the simplest terms, copper prices are rising, increasing by 2.8% in trading on the London Metal Exchange last week by 2.8%. In both the near and longer terms, Chinese participation is a critical driver of demand. In a report recently issued by the International Copper Study Group (ICSG), over the past 10 years, Chinese consumption of copper has risen by 185%. The increase means that where China once consumed 18% of available supply, it now accounts for over 40% of consumption. As such, recent softness in the copper market can be directly linked to the Chinese economy, which has seen declining GDP growth. As these numbers begin to firm, it is bullish for copper prices.
In the first half of 2012, it appears that demand has outpaced supply creating an early shortage that is likely to continue into the latter part of the year. Over the period, primary mine production added 2.4% in capacity while usage surged 7.3% on a global basis. The recently announced Chinese investment of $156 billion in stimulus, largely in infrastructure expansion, is only likely to bolster demand and consumption further. When project-specific demand growth is added to an improving Chinese GDP picture, the combined impact is very bullish.
Freeport’s Grasberg mine, which accounted for 19% of the company’s revenue last year, is facing a potential hike in the level of royalties that must be paid to the Indonesian government. While the royalty review is not slated to be complete until the end of 2013, the hike involved is significant. Currently, both Freeport and competitor Vale (NYSE: VALE) pay a 1% royalty on gold and a 3.5% royalty on copper mined in the company. The team formed earlier this year to review royalty contracts is contemplating hiking the rate for each to 10%.
The would pose a significant hike in the company’s cost structure, particularly given the reliance Freeport places on the Grasberg mine. Vale’s exposure is also significant, but the two companies may be faced with little option other than to pay. It remains unclear when the impact of the hike would be felt, but it is a risk that should be noted before proceeding with an investment.
The Gold Angle
While the strengthening copper market is the focus of this discussion, the role of gold should not be overlooked. Unlike competitor Southern Copper (NYSE: SCCO), which has exposure almost exclusively to copper, Freeport continues to have extensive gold exposure. Southern Copper is a more pure play on copper, but Freeport’s gold exposure gives it significant protection against another downturn in the copper market. Southern has no Indonesian exposure, so its lack of protection may be less an issue, but given the U.S. inflation picture, gold exposure is a very positive advantage.
While gold prices have not spiked, the recent announcement by the Federal Reserve that it will begin pumping $4 billion into the economy each month will eventually lead to significant inflation. There is some possibility that the economy – or, more specifically, the labor market – will improve before the inflationary impact of the latest quantitative easing is felt, but this seems remote. Inflation and inflation expectations are likely to drive gold prices higher, giving Freeport another driver of performance.
The improving case for copper should be seen as a positive catalyst for buying Freeport. As Chinese demand returns, copper prices should rise as demand outpaces supply. The protection afforded the company by its exposure to gold make the stock a buy at current levels.
Mr. Ehrman 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.