A Rare Opportunity to Profit from Copper Prices

Have you ever noticed how the market can stop and turn on a dime just when the majority of investors are sure it’s going to keep moving in the other direction? It’s a phenomenon also observed at the sector level and even within the commodities market. Being aware of this phenomenon can often present solid trading opportunities.#-ad_banner-#

As it turns out, there’s such a trading opportunity taking shape right now for investors willing to see things as they are, rather than how the crowd sees them.

Here’s the story…

Not even close to being in a freefall
It’s not exactly a secret that copper had a miserable summer. 

Although prices rebounded from $3.40 per pound in late 2011 to highs of about $3.90 by February, the upward trend wasn’t to be sustained. By April, when the situation in Europe started to deteriorate again and China’s growth pace slowed, the market panicked, sending most commodity prices lower. Copper was hit particularly hard, falling to about $3.30 per pound, which was close to a two-year low — and worse — prices got stuck in a rut around that value. 

The lack of a rebound in copper prices convinced a lot of investors and the media that the stalled price trend was the calm before the next bearish storm.

Then a funny thing happened on the way to that implosion: Copper prices began to soar. 

Contrary to popular belief, neither copper nor the global economy was racing to the edge of a cliff. It was simply a rest period for what was about to unfold beginning Wednesday, Sept. 5.

The European Central Bank‘s decision to step in and recapitalize the region’s struggling member nations may have been the catalyst, but it’s not the reason copper prices continued to soar last week and into this week. 

Copper jumped to a multi-month high close of $3.51 per pound on Sept. 6, and to erase any doubt about its recovery, has since rallied to a four-month high of $3.64. The momentum doesn’t seem to be fading either. If there’s one thing a recent chart of copper prices has taught us, it’s that once the chart really starts to move in earnest, it doesn’t stop for a while.

But how did so many people miss this move in the first place? While prices may have been sliding, copper consumption never actually slowed. The London Metal Exchange’s recorded warehouse levels (of available copper inventories) dwindled to four-year lows in May and are knocking on the door of even lower lows. The COMEX copper warehouse stocks index is also plunging beginning this week. Both trends verify that copper is still in demand despite this summer’s depressed price. 

Ways to play
There are a handful of ways to tap into this budding trend. One of them is iPath Dow Jones UBS Copper Total Return Sub-Index ETN (NYSE: JJC), which essentially mirrors the changing price of copper itself. Though, it may not move as well as copper-mining stocks, such as Southern Copper Corp. (NYSE: SCCO) or Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX).

Of the two, Southern Copper is the better option for most traders. 

Not that gold is a liability at this point in time, but Freeport-McMoRan’s heavier exposure to gold adds a speculative aspect to its shares right now. Southern Copper Corp., in contrast, is almost a pure copper enterprise, with just a little silver and molybdenum thrown into the mix. All three metals are used industrially, whereas gold is used heavily for speculative proposes and jewelry. For most investors, Southern Copper is an easy way to participate in global economic growth directly, while Freeport may or may not be.

More important, Southern Copper has a consistent track record of strong profits when copper prices are firm like they’re becoming now. 

For example, in 2007, when copper prices averaged then an all-time high of $3.22 per pound, the company posted its strongest-ever per-share profits of $2.48. In 2009, when copper fell to a multi-year low average of $2.39 per pound, Southern Copper’s earnings fell to a multi-year low of $1.08 per share. The corporation‘s per-share profits jumped to a new record of $2.73 in 2011 when copper prices averaged a record $3.98 per pound. Point being, the correlation between copper prices and Southern Copper’s profits is clear, for better and worse.

Now, with copper prices setting up a strong finish for the year, the bottom line for the current and upcoming quarter should be even more than impressive. 

Risks to Consider: For the same reason, rising copper prices mean a boost for the company’s net income, as an unexpected tumble in copper prices will almost assuredly lead to weakened net income for Southern Copper. This is a very direct copper-price trade.

Action to Take –> The company is already due solid numbers for the current quarter. But if copper can make it back to the $3.80 per pound range at which it traded in the first quarter of the year — a mere 5% increase in its current price — then Southern Copper’s bottom line would get an enormous boost. Assuming such a move is in the cards for copper, one could make the case that Southern Copper shares could see a 20% advance by the time next quarter’s numbers are posted in early 2013. 

And if copper continues to increase in price beyond $3.80 per pound into next year, then the miner’s earnings will likely start to grow exponentially, making the stock attractive through mid-2013.