Forget Gold — Here’s Another Resource Play With Double-Digit Potential

I feel the same way about gold right now as I did about tech stocks in the late 1990s — that it’s far too late to get in. Just the fact that no one can agree if there’s a gold bubble is enough to turn me off to the yellow metal. You may recall that a similar debate raged about tech stocks right up until that bubble popped. [To read my colleague Sumit Roy’s take on gold, click here.]

If you’re thinking of buying gold, consider holding off until you can be reasonably certain of its merit — which could be a long time. At least be cautious by building a position gradually, for example, or using out-of-the-money call options as The Wall Street Journal recently advised. (Interestingly, the article containing that advice also argued against a gold bubble.)

Look to other metals
Better yet, invest in some other metal. The one I’m thinking of is far more versatile, having many industrial uses, and it’s not on everyone’s radar like gold. Whereas gold may be nothing but dangerous going forward, this other metal has the potential to earn you +10% a year or more for the next several years.

That’s largely because demand for it is expected to continue rising quickly in emerging markets such as India, Indonesia, Peru and particularly China. These growing nations will need millions of tons of the metal for electrical wiring, industrial machinery, ship building, computers, pipes and many other applications.

The metal, as you may have guessed, is copper.

To get the kind of return I mentioned, consider investing in Southern Copper (NYSE: SCCO), a $31 billion mining operation with facilities in Chile, Mexico and Peru. While the company is obviously in the copper business, its mining operations also yield other valuable metals including silver, zinc and molybdenum.

At the current price of about $38, the stock is close to its one-year high and may not run up again for a while. A pullback seems more likely at this point.

However, the stock should reward investors well during the next three or four years as copper production is increased to meet Asian demand. I anticipate returns of at least +10% annually including dividends, which, incidentally, few other copper miners provide in any meaningful way. Southern Copper’s 3.7% current yield is six times the 0.6% that competitor Freeport-McMoRan (NYSE: FCX) pays, and twelve times the industry average of 0.3%.

The case for attractive returns
Two important developments at Southern Copper have set the stage for its stock to deliver strong long-term returns. First, operations recently resumed at the company’s Cananea, Mexico mine, which had been essentially out of commission for two years because of labor disputes. The mine holds 60% of the company’s copper reserves.

Second, the company recently approved a five-year, $3.8 billion expansion program at Cananea. The aim is to more than double copper production there from 180,000 tons to 450,000 tons annually. A $1.8 billion expansion program already underway at the company’s mine in Peru, and is expected to add another 292,000 tons annually.

That puts Southern Copper on track to grow earnings by about +16% per year, on average, for at least a few years, with an increase of +25% to +30% forecasted for 2011. The company’s net profit margin will likely jump into the 35% range from about 29% now, and it should be able to maintain a dividend yield close to 4%.

Action to Take –> Considering the recent run-up, it also seems reasonable to wait for Southern Copper to pull back some before buying. Of course, that sort of market timing can be hazardous because the stock might resume its advance, with the price quickly rising to the point that it’s no longer a good value.

So by all means, buy Southern Copper now. With a forward P/E of about 14, it’s still a good value despite the recent run-up in price. Furthermore, I consider a total return estimate of +10% per year to be on the conservative side. The stock is capable of delivering as much as +15% annually, which translates to a +75% gain between now and 2015.