Friday, November 19, 2010

Thoughts on Copper and other Commodities

I went to go see Pete Ward, metals and mining analyst at Barclays, yesterday.

Pete, in my opinion, is one of the best analysts in this space. He has been following the group for probably 15 years or so, and has made some terrific calls on his stocks during that time.

Interestingly, before he went to Wall Street, he was a gold buyer for a jewelry company for 10 years, so he has been involved in the industry from a couple of different perspectives.

Pete has been bullish on copper for some time, and remains a "raging bull". The reason, says Pete, is simple demand/supply.

The demand for copper remains robust worldwide. Thirty years ago this demand might have come largely from the telecom companies for use in copper wires, but this has essentially ended (nearly all fiber laid today is fiber optic). Instead, copper is used in areas that require efficient uses of conducting electricity, which means automobile production (especially the new electric cars); housing; and electric grids.

This last part was particularly interesting to me. In the United States, our electricity is largely produced the way it was back when Thomas Edison discovered electricity. Fuel is shipped to a power plant, which then produces the electricity that is then distributed to local customers. The relatively flat topography of the U.S. makes this possible.

However, in the rest of the world, the distribution of electricity is done mostly through copper wires. In China, for example, Pete discussed how the simple vastness of the countryside - coupled with a very rocky terrain - makes transportation of fuel over long distances impractical. Instead, the Chinese will string copper wiring over mountainous terrain to get the electricity to where it is needed.

Thus, this means that Chinese demand for copper will only grow over time. Copper remains the best conductor of electricity - there is no better alternative on the horizon.

Problem is, copper mining is still an incredibly labor and capital intensive business. Opening a new copper mine almost anywhere in the world takes at least 7 to 10 years, assuming there is sufficient copper veins to warrant exploration. And since there are no new mines being opening, this means essentially no new supply.

The newest copper mines are being opened in fairly nasty places, like the Congo and Mongolia. Pete went to the Congo last year, and described an incredibly dangerous environment (he does not plan on returning any time soon, by the way).

The best way to play copper, according to Pete, is Freeport-McMoRan Copper & Gold (ticker FCX). The stock has had a terrific move over the last year, but Pete says there is still a good deal of upside to come. The fact that there are a lot of skeptics on copper is actually good news, said Pete, and I agree: big moves in stocks rarely occur when there is already widespread bullish consensus.

Moving on to the other commodities: Pete still likes the coal stocks, feeling that the market does not appreciate the continuing demand for the fuel despite the environmental concerns.

Interestingly, Pete does not like gold or gold stocks. As a former buyer of gold, Pete finds the current widespread bullish sentiment on gold puzzling. Unlike other commodities, gold is only used in the making of jewelry, and this is not sufficient reason for the recent rise in the price of gold. Moreover, Pete notes that Chinese women often prefer silver jewelry rather than gold, since it matches better against the color of their skin.

Finally, Pete is also not a fan of aluminum. Too much supply (again from China) and not sufficient demand makes Pete a little wary of names like Alcoa.