Several Factors Will Benefit Copper Stocks

 | Nov 20, 2013 | 1:00 PM EST
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The outlook for copper prices may be improving. They've been weak for a while and trading not far from three-year lows, marking time with the slow economic activity and weak demand. Things may be about to change.

That's because one of the most important factors in the copper market, China, looks like it is turning around. At least it appears that way on the heels of a recent new policy announcement ending decades of the "one child rule." All the monetary machinations that did nothing for China's economy are now overshadowed by something that could really make a difference. There is no better way to stimulate domestic consumption and a nation's economy than to let people have kids and start families.

Copper inventories have recently started to fall. Stocks on the London Metal Exchange (LME) have declined about 50,000 tons in the past month while Comex copper stocks are down 7,000 tons over that same period. Mine production this year is expected to rise only modestly from earlier forecasts of a much larger increase. In addition, inventory rebuilding is occurring. Taken all together, these things are constructive for the price of copper.

I should also mention that industrial production in the U.S. has risen to levels not seen since the financial crash and Great Recession. I also think investors have got the "taper" scenario all wrong. First, I don't think the Fed will taper anytime soon; more importantly, the bearish effects of taper are overblown. While we could see a selloff in commodity prices initially, I think that could abate rather quickly. Markets believe taper to be a headwind, but it's not because fewer bond purchases means more interest income remains in the economy. That's not deflationary.

Given the improving picture for copper, the stocks of copper producers look undervalued. Take Freeport McMoran (FCX), for example. While the stock is up about 33% from its mid-July lows, it still can climb. It looks very reasonably- priced with an earnings yield of 7.6% and a dividend of 3.40%. Who would not like to own it? At these levels it looks like a terrific bargain.

Then there's Southern Copper (SCCO). Same story. The stock is attractively priced with a 7.8% earnings yield and a dividend of just under 2.0%. Given the improving outlook for copper prices, this company also looks like a good bargain.

Both stocks had recently been down about 50% from their 2011 highs. Interest has waned considerably. This is a contrarian's dream. The only risk in this equation as far as I can see is that we have another debilitating government shutdown come January, but I don't see that happening. The Republicans sustained too much political damage on the last one and besides, they have the highly unpopular Affordable Care Act to use as a political weapon in 2014.

So with mine supply in balance or below expectations, demand improving and the world's largest consuming nation embarking down a completely new policy path, taking a shot on copper seems like a low risk, high reward bet.

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