Is the bull in Copper over? Red Gold is flashing red now but all is good in the long run

On September 29th, 2011, shares in Montreal-based Anvil Mining (TSX: AVM) soared after a $1.3-billion friendly takeover offer from Chinese mining giant Minmetals Resources. The Minmetals bid of $8 was a 38 per cent premium over Anvil’s close the day before. Anvil’s operations are in the Democratic Republic of Congo. This is the same Minmetals that was beaten out by Barrick Gold Corp (NYSE: ABX) in April of this year when it tried to take over Equinox Minerals, a firm focused on copper mining in Zambia. It is interesting to note that Anvil is in DRC, with operations in Katanga province, which boarders Zambia. Both Zambia and the Katanga province in DRC are parts of a prolific and newly emerging copper belt in Africa.

So why such interest in a company that is mining copper when copper seems to be in a free fall lately?

This blog will answer that question and will also explain why it may be a smart idea to consider getting some exposure to beaten down copper plays.

Copper is considered a barometer of economic health and is revered for its forecasting guidance. You need copper for all sorts of things. Consider this: when you speak to someone on your mobile phone, fire up your computer to do some work or step inside your car; you are using some copper. For example, an average car has 25 kilos of copper inside. Copper is used not only to cable or wire the globe but also in all types of electronic devices.

So what do recent gyrations in copper’s price indicate? Well, the signs are ominous and copper is flashing red. After holding at historically high levels of over $4/lb as late as September 5, 2011, the bottom seems to have fallen from copper’s prices. Just in one month alone the red gold, as it is affectionately known as, has given up over 20%. After reaching a high of $4.6/lb six months ago, the price of copper fell below a crucial support level of $3/pl this week before bouncing back and closing at $3.27 on October 6th, 2011.

With such a rapid decline in just a few weeks, many pundits are already writing the obituary for copper. I would argue however that this weakness in copper is a short-term phenomenon and the long term looks promising for the red metal.

The case in favour of copper rests on very strong fundamentals. First of all, the world cannot manage without copper. There are no easy substitutes. From electric cables inside homes to electric wiring on billions of electronic gadgets, copper has no close competition.

As the emerging economies of China, India, Brazil roar ahead, the demand for copper will only increase. As a matter of fact, fast growing developing countries now account for over two third of demand for copper. China alone consumes over 40% of copper produced globally. This could also explain the current upheaval in copper prices as concerns grow that China’s economic growth might be slowing down a little from its torrent pace. These countries have a long way to go before they are urbanized and modernized. All this will mean that these emerging economies will need a whole lot more copper in coming years.

Another important factor working in favour of copper is the fact that supply is generally constrained, as not many large new deposits are being discovered. Furthermore, copper is relatively more difficult and expensive to extract. The production in old mines in traditional copper heavyweight countries like Chile and Australia has peaked and no new mine has recently commenced operation or is likely to start producing copper on the scale that is even close to what the biggest mine in Chile, the Escondida copper mine, has been able to achieve.

No wonder that countries like China and India are looking for good copper deposits all over the world and hence the quest by Minmetals, a Chinese government owned entity, to acquire companies with promising copper deposits. Minmetal’s attempt to pay a hefty premium to acquire a company like Anvil Mining even when copper has been on free fall is not surprising therefore. This also explains why a company like Barrick Gold Corp. is betting a part of its future on copper by acquiring Equinox Minerals.

To summarize, copper may be down now but it is certainly not out. The fundamentals support a very bullish case in the long term. Investors should use the opportunity presented by the weakness in copper prices to get exposure to either beaten down high quality copper producers such as First Quantum Mineral (TSX: FM) or directly to copper through some copper specific ETF such as Horizons BetaPro COMEX Copper ETF (TSX: HUK).

The author and his firm do not hold any shares position in the companies mentioned in this blog.