The Second “Last Five Minutes” Play from Peter Krauth

by Travis Johnson, Stock Gumshoe | September 20, 2012 1:06 pm

Sniffing out another Real Asset Returns teaser -- "The outlook for copper is doubly hot"

As promised, we’re taking another day to have a look at the “last five minutes” pitch that so many of you have been asking about.

If you missed our first installment, you can go here to see that note — and get the background on that “last five minutes” means. In short, it’s a spiel that’s based on the fact that exponential consumption growth of commodities is going to lead to a dramatic spike in their prices. The other tease was for an agriculture[1]-related commodity, potash[2] (that’s a fertilizer[3] component), today’s is for a more widely-traded industrial metal … here’s a taste of the pitch:

“URGENT ‘FIVE-MINUTE EFFECT’ PLAY #2

“Did you know that there’s over a mile of copper[4] wire in every car built?

“You’ll know it soon by the metal’s price.

“… three billion more people are joining the middle-class ranks over just the next 18 years…

“And there’s copper in everything important to their lives. The pipes that carry their water[5], the wiring in their cars, homes, offices, schools, hospitals, and more.

“Whenever growth is in the picture, copper’s hot.

“And with population, development and consumption exploding globally…

“The outlook for copper is doubly hot in these ‘last five minutes’ of cheap resources.”

So that’s the big picture: buy copper. He also talked quite a bit about the “golden cross” in this ad, and copper, like several other commodities, is at least close to a golden cross on their chart — the 20 day moving average has almost hit the 200 day moving average for the ETN that tracks copper and for the major index of copper mining stocks, though I didn’t check the actual futures trading charts. That’s almost, thanks to the recent spike up in prices during the last two weeks, when copper has moved up about 10%, but not quite — and part of the reason that it’s called a golden cross is that the cross has to happen, otherwise the 200 day moving average acts like a resistance ceiling.

Or at least, that’s how the technicians describe it to me. I don’t think the Chinese factory managers who are deciding how much copper to order are basing it on the 200 day moving average, so I have a hard time taking the charts very seriously as a fundamental investor — but yes, they do have some power to describe the trading behavior of human beings, and sometimes they have predictive power … I just take it with a grain of salt.

So anyway, that’s the basic copper story — it’s called the “metal with a PhD in economics” (that’s why you’ll sometimes hear the “Dr. Copper” term) because of its importance to the global economy … movements in the copper price are a good indicator for the economy is doing, though over the long term (decades) the metal tends to stay pretty close to other broad indicators of global economic performance, like the S&P 500 index. Copper is more complicated now than it might have been a decade ago, partly because the Chinese are the major consumers of copper for their factories and their infrasctucture buildout — and their inventories are not as transparent as the inventories of the big futures or commodities trading houses. China[6] imported record amounts of copper earlier this year, but many investors were convinced that they were just hoarding it, which might depress their future demand for imports.

I am not a commodities expert, to be clear, that’s just the basic spiel that I hear over and over. So let’s move on to see what Krauth thinks is the best “last five minutes” play for copper … what’s he specifically teasing? Clues in this brief excerpt from the ad:

“There are lots of ways to play this vital industrial metal…

“But the BEST way I know of to play it right now is this American firm. They’ve got under-the-radar stranglehold on some the world’s largest copper deposits.

“They’ve also corned impressive quantities of zinc[7], moly, and lead into the bargain.

“With projected copper demand over the next 25 years estimated to surpass all of history to this point…

“Companies with the biggest in-ground reserves will fare the best. Especially from a profit-margin standpoint.

“And this company produces copper at less than 10% of today’s market price!

“That leaves 90% in profits for acquisitions, development of new resource deals, equipment and infrastructure. Not to mention handsome dividends[8] to shareholders.

“With fundamentals like these, it’s no wonder that shares have gone up 208% since Q4 of 2008…

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“That’s right: They’ve more than tripled in value DURING the worst domestic and global financial malaise of our lifetimes.

“But this is a drop in the bucket compared to what this company’s in position to do.

“Of all the commodities-related investments on my radar for the Real Asset Returns[9] model portfolio right now…

“This one has the potential to go the farthest.

“In my opinion, it could beat the 3,977% gains Thompson Creek pulled down for investors in 2005 to 2007.

“But you must get in now if you want a shot at this caliber of returns. These metals-focused stocks can move lightning fast….”

Well … pretty much all copper producers bottomed out in the fourth quarter of 2008, so being up 208% since then is not so remarkable. Most of the big ones have not yet recovered to where their share price was five years ago, since, as we see so often, rebuilding a stock’s valuation takes quite a bit longer than crushing it. So which copper company is he teasing?

The two biggest US copper companies are the massive one you’ve almost certainly heard of, Freeport McMoran (FCX), with their massive Grasberg mine in Indonesia[10] that gushes both copper and gold, and which has for years traded as a proxy for copper on Wall Street (at least in the days before ETFs and the democratization of commodities trading), and the Western Hemisphere copper giant that not as many people know, Southern Copper (SCCO)[11], formerly known as Southern Peru[12] Copper. Both are headquartered in Phoenix, Arizona, but depend on massive deposits in less reliable regulatory regimes (Indonesia, Peru and Argentina[13]), and both produce copper quite inexpensively, partly because of “by product credits” as they put the cash proceeds from the gold, molybdenum[14], silver[15], etc. that they also find into covering their mining costs and reducing their effective cash cost per pound of copper.

Nobody really “produces” copper at less than a tenth of today’s market price, though — I’m not aware of anyone who can explore, drill,excavate, process and sell copper without incurring costs significantly more than 38 cents a pound (copper costs roughly $3.75 a pound on the open market today). The “cash cost”, however, is substantially below that — they leave out corporate costs and indirect costs to get those numbers, and they’re not necessarily consistent across companies, but on that front Southern Copper is substantially lower-cost than Freeport-McMoran when it comes to extracting copper … and they did report a cash cost per pound of about 40 cents for 2011, which is pretty close to 10% of the market price, while Freeport’s number, the “unit net cash cost per pound (which may not be comparable) was up to about a dollar in 2011 and is higher now). Likewise, SCCO has consistently been more profitable on each dollar of sales for several years, with gross and net margins that are measurably stronger than Freeport’s.

So if we’re really talking about a company that has substantial copper reserves and low cost production, and is relatively little-known, then the best solution for this teaser is Southern Copper (SCCO). And as a small added clue to get us to SCCO over FCX for this solution, Southern Copper produces meaningful amounts of lead in addition to zinc and molybdenum, all three of which were teased as byproducts above, and Freeport’s major mines don’t typically mention lead as a byproduct. I can’t be 100% certain of this one given the limited clues, but I’m pretty sure.

And unlike Peter Krauth[16], I’ll be pretty surprised if it generates 4,000% returns over the next couple years like Thompson Creek did — but SCCO is certainly one of the larger copper miners and may have the most massive reserves (enough for 100 years or more at current rates, we’re told). It is also a dividend-focused company, with historically very high dividends and a current payout ratio that is pretty high for a miner (around 80%) … it’s also really a subsidiary of another corporation (Grupo Mexico[17], a large Mexican mining conglomerate owns 80% of Southern Copper — and could, therefore, actually, be a decent match for the teaser as well, though it’s harder to buy — ticker is GMBXF on the pink sheets, GMEXICOB on the Mexico exchange).

SCCO’s dividend will probably grow substantially if copper prices hit a sustained recovery, since they focus heavily on dividend payouts, though like FCX they’re subject to plenty of regulatory and labor risk at their major mines — so violent protests or strikes or changes to the tax rate or royalty rate on their mines are always in the back of investors’ minds. FCX, on the other hand, balances its copper exposure with the fact that Grasberg, their core copper asset, is also one of the largest gold mines in the world, and gold can sometimes (as in the last several years, when it has dramatically outperformed copper) perform a very different role in your portfolio than the more industrial commodities. And they also pay a solid and growing dividend, with, at least recently, a lower payout ratio. SCCO has done somewhat better than FCX over the last six months or so, and recently tickled their 52-week high on the copper recovery, but, as you might expect, the two have traded almost in lockstep over the past five years.

And if it’s just the basic idea of investing in big copper miners that you like, and you don’t want to pick a favorite, you can always buy a diversified basket of copper miners using an ETF … the First Trust ISE Global Copper Index[18] (ticker CU) has SCCO and Freeport-McMoran and other major names you probably know like Xstrata and Rio Tinto among its top ten holdings, along with some companies I’ve never heard of — it has performed slightly worse than SCCO and FCX since inception, but only by a couple ticks, and also has a dividend yield of around 3-4%.

So that’s how it appears from this end of the spiel — it looks to me, though I can’t be 100% sure, that Peter Krauth is touting Southern Copper, which has done slightly better than the average major copper miner over the last year and has a low-cost, long-lived portfolio of reserves and a fairly aggressive dividend policy. Think it’s a good match for your portfolio? Too worried about commodity price, political risk, management, or something else? Let us know with a comment below.

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