China's Slowdown Is Hurting Copper

Nathaniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The past two weeks have been turbulent (to say the least) due in large part to increasing fears coming out of Asia. Why is China significant for the American investor? Well, many companies have banked on the country for growth in the decades ahead. Thus, slowing growth out of China would deflate the valuations of these companies. 

China slowdown

China seems to be slowing down by all conventional measures, and unfortunately it seems the government is hesitant to step in. The slowdown is being driven by severely diminished wage growth, slowing global demand, and the Chinese government tightening its wasteful spending policies.

The majority of Wall Street's powerhouse banking institutions have already lowered their GDP estimates below the key 7.5% level. More recently, the Asian markets were rocked as fears of a credit crunch made waves. Keeping liquidity in place is key for builders, property investors, and banks.

Copper isn't doing well

When rates rise drastically, as they did during our own 2008 financial crisis, a chain reaction occurs which messes with all aspects of the economy. Rates hit an all-time intra-day high of 30% before pulling back to roughly 11%. This brings me to Freeport-McMoRan Copper & Gold (NYSE: FCX), an industry-leading producer of copper, gold, and gas. Shares of the company have tumbled amidst a slew of headwinds, including falling copper prices.

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The iPath DJ-UBS Copper Subindex ETN (NYSEMKT: JJC) is an exchange traded note designed to follow the price movements in direct correlation with physical copper prices. As you can see, both Freeport and Copper have experienced high correlation over a great period of time.

Just last week, copper extended to a 3-year low. Demand from China accounts for around 40% of global copper consumption, thus a demand slowdown could create a huge copper surplus. Some analysts have predicted prices will fall an additional 10% before finding support. In a recent Bloomberg report, analyst Ross Strachan, economist at Capital Economics, stated

Looking at fundamentals it would suggest that there is further downside for copper. We expect prices to fall below $6,000 a tonne next year due to additional mine supply and the weak state of demand.

Should we begin to see tightening policy, slowing growth, and higher interest rates in China, the industrial demand for copper should fall drastically. At the end of the day, Freeport-McMoran and the copper etn are proxies for the price of copper.  You should expect shares to continue to follow copper in its trajectory.

Additionally I would encourage investors to avoid the entire copper sector including Southern Copper Corporation (NYSE: SCCO), as the company has a similarly high correlation to copper prices. 

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Southern Copper, as its name would imply, focuses almost entirely on the production of copper through its South American operations. While the company does produce a variety of other industrial metals, its revenues will be in direct correlation with copper prices and therefore should trade in tandem with copper futures.

However, the company isn't going anywhere. Current assets, largely cash, drastically outweigh current liabilities. The majority of the company's liabilities are in the form of long term debt which  gives investors cash flow certainty over the shorter term. While analysts are expecting negative 15.9% growth this year, it shouldn't be long before it rebounds. 

Foolish wrap up

Due to China's economic slowdown, it seems likely copper prices will continue to fall in the near term. So Investors may want to avoid companies with high exposure to the underlying price of copper. If you are looking to hedge your positions in either Freeport or Southern Copper, you could do so by shorting the copper ETN mentioned above. 

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Nathaniel Matherson has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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