Metals Continue to Struggle

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

Metals such as copper and aluminum continue to struggle and even investment commodities like gold are not doing too well. Digging stuff up from the earth was a far better business a decade ago than it is now. However, keep in mind that 2013 is far better than 2009 was.

Consider how the market has been making new highs the last few years and then look at some of the top mining companies like Freeport-McMoRan Copper & Gold (NYSE: FCX) or Alcoa (NYSE: AA) and see how disappointing they have been. Freeport is down almost 10% over the last three years. I expected raw materials to start bouncing back, but it seems that it will take some time.

Freeport hatred

There are plenty of people unhappy with Freeport’s entry into the oil and gas market with its massive acquisition. I do not see the diversity as a bad thing. Oil and gas are currently doing better than metals. The last earnings call was prior to the acquisition closing. The deal is done now, but there has not been an earnings release subsequent to the acquisition.

There are a few things that I see as beneficial to the whole company from the acquisition. I don’t think the geographic diversity is something that should be discounted. Freeport and Indonesia fall in the same sentence nonstop, but the oil and gas assets are in the United States. Freeport is a foreign company in Indonesia and there are complex issues stemming from the indigenous population and environmental issues.

General commodity diversity is a good thing for the company, too. The recent Grasberg tunnel collapse frames this really well. It is Freeport’s key copper mine, and the closing of the mine along with a force majeure invocation has turned a plentiful of copper supply into a tight supply situation. Constrained supply might bump prices that could benefit some other copper producers, but since it is Freeport’s mine that is shut down, the volume of copper sold will shrink for the company. The probe into the causes of the tunnel collapse could take months, and each day Freeport is not mining 3 million pounds of copper.

The addition of oil and gas to the solid copper business, with a side of gold, makes me like Freeport better than Barrick Gold (NYSE: ABX). When I was looking into the gold mining term “all-in sustaining cash cost,” I discovered that the companies got to capitalize half the cost of developing a project in creating that number. That masks a lot of the cash costs for companies extracting gold, making the profit per ounce seem greater than it is. A developed project is not something I would really call much of an asset.

For a company like Barrick, there is no selling the mine to some other concern. Barrick would be the kind of company buying those mines and infusing cash to a smaller company. Barrick’s stock return speaks for itself, down over 50% in three years, but if you look at its cost per ounce and the current price of gold, you might think it is still a good deal.

Low hanging fruit is gone when it comes to gold. All these projects cost a lot to develop, and Barrick has to spend a lot of money to extract the ounces of gold. In those terms, its costs do not end up looking that great. If gold heads any lower, it could be extremely bad for the company, and I do not like the risk-reward for gold miners anymore. Freeport is about copper with gold as a byproduct.

The last thing to note for Freeport is that over 1 million shares were bought indirectly by an insider who is the CEO of Freeport-McMoRan Oil & Gas, not the parent Copper & Gold. That is a nice vote of confidence from someone heading up the more hated segment of the company, but do not rely too heavily on that. The amount is large enough to be worth noting.

I think Freeport will rise higher eventually, but I am starting to think it will not be till 2014 or more likely 2015. That is a long time to sit on a flat stock, though there is a dividend that yields over 4%. Results might be adversely impacted by the Grasberg closure, so I would wait a bit to find out where the bottom is.

Alcoa malaise

Alcoa needs aluminum prices to rise if it is going to see its profits grow. Right now, it is operating on paper thin margins. Margins are so thin that the company is better off cutting expenses and waiting for a favorable market rather than trying to boost returns by going for more volume. The short-term, meaning three years, looks very rough for Alcoa. I do like the long-term possibilities stemming from its extreme cost-cutting initiatives. When aluminum prices rebound, Alcoa could see massive profits since it has become a lean, mean aluminum machine.

The unanswerable question is when aluminum will rise, and whether Alcoa will be in good condition when that happens. It could be a few years judging by the overall trajectory of metals. With the recent optimism surrounding the global economy, I would think an industrial metal would start seeing increased demand, but prices still remain under pressure.

Alcoa has been hovering around $8 for a while, and if one is willing to be extremely patient, it could be a good investment. There is always a risk the company could hit a roadblock and tumble further. I would consider buying half the position I want and writing puts lower to collect the premiums or average down if I am assigned.

Conclusion

Both Freeport and Alcoa require a large amount of patience, but at least Freeport rewards you with a dividend. On the other hand, Alcoa has been stable in its $8 area and has no specific bad news. Freeport has one of its key mines shutdown, potentially for months. Metals have had it rough, and the future continues to look bleak. I would not short the stocks as Alcoa has been very stable. You would have to pay the dividend for Freeport unless it crashes quickly. You can wait for an entry, or be long and show a saint-like patience.

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Nihar Patel 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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