Copper's Golden Hue

It's a familiar tale. World prices for an industrial commodity soar to record highs as growth in demand -- particularly from rapidly industrializing giants like China and India -- outstrips increases in output. Talk of nationalization by populist leaders in Third World countries roils the market, and speculators pile in hoping for outsize returns.

Thinking of oil? Not this time. The precious resource we're talking about is copper. Prices for the base metal hit an all-time high of $7,815 a metric ton on Tuesday, May 9, the same day that gold topped $700 an ounce, its highest level in 25 years.

And copper prices haven't peaked yet, in all likelihood, despite a nearly 80% run-up since the start of the year. Supplies are stretched tight. Industrialization and urbanization -- the twin forces reshaping the economies of China and India -- are also stoking demand, as copper is needed for construction and the manufacture of everything from cars to microprocessors.

Producers from Chile to Indonesia have been racing to bring new production online, but the larger companies say they are already running at full tilt. "We are very stretched," says Juan Eduardo Herrera, senior vice president for strategy and business development for Corporación Nacional del Cobre de Chile, or Codelco -- the state-owned company that is the world's No.1 copper producer. Herrera says his plants are running at "110% of capacity."


  Copper inventories are now running at perilously low levels. Those monitored by the London Metal Exchange are down to less than three days of consumption. "There's never been a situation like this, it's extremely tenuous," says Peter Schiff, president of Euro Pacific Capital, a 16-year-old independent brokerage in Darien, Conn., that specializes in international markets. "Any small disruption to output anywhere in the world and there's going to be huge shortages."

While a crisis has so far been averted, inventories have been whittled down by a six-week strike at La Caridad, a mine operated by Grupo México, the world's seventh-largest copper producer. Meanwhile, in Peru, which ranks in the global top10 in terms of output of refined copper, the frontrunner in the presidential race has threatened to nationalize mining assets. Such talk is another factor putting upward pressure on copper prices.

Even without any major disruption in supply, it will be difficult for producers to catch up to demand. Analyst Dan Roling of Merrill Lynch & Co. (MER) figures copper production levels will need to rise 12% to 21% from 2005 levels to accommodate accelerating demand in the second half of the decade. His research suggests that large mines are generally older and susceptible to disruption, while newer ones "don't have enough incremental supply to meet demand."

The volatility in the market is squeezing profits at industrial companies that rely on the red metal. On May 5, for example, Princeton (N.J.) -based conglomerate Tyco Intl. (TYC) cut its forecast for full-year earnings, citing soaring copper prices. "If you're paying three times what you paid a year ago, it's obviously going to hurt. It hurts your cash position and makes life extremely difficult," notes Codelco's Herrera.


  For leading producers, these are good times, though. Chile's copper exports jumped 53%, to $6 billion, in the first quarter, compared with the same period last year. Similarly, Freeport-McMoRan Copper & Gold (FCX), a New Orleans-based company with large copper mines in Indonesia, reported in mid-April that its first quarter profit nearly doubled, to $251.7 million, on skyrocketing copper and gold prices. The bull market in metals is also spurring merger activity. On May 9, Teck Cominco Ltd, a Canadian company that is the world's largest zinc producer, announced it was making a $16 billion play for nickel and copper producer Inco (N).

All of this is proof to some investors that a long-running rally in metals is in the works. One believer is Adam Hamilton of Zeal LLC, a North Dakota-based private consulting company that publishes research. "We are riding this bull by buying stock in both elite and up-and-coming commodities producers," he says. While copper prices may fall back somewhat from their current stratospheric highs, analysts believe that medium- to long-term trends will keep them from bottoming out, as they did in 2001-2002.

At this rate, even the lowly penny will soon be worth far more than its face value. One-cent coins minted by the U.S. government aren't made of just copper anymore, but mostly of zinc. This change was made in 1982 in order to save the Treasury money. So sock away those pre-1982 pennies, says Schiff of Euro Pacific Capital: "Put them in a piggy bank," he advises. "Each is now worth two cents." Depending on what happens with copper prices, the value could go as high as a nickel. Not a bad return on investment.

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