Insider's take on the copper correction

10/20/2011 8:11:54 AM | Matt Badiali, Growth Stock Wire

With a production cost of just 79 cents per pound this company can remain standing through much worse

It's one of the most dramatic moves of 2011...

In just one month, copper – one of the world's most important building materials – fell 25% in price.

To get an "insider" perspective on the drop, I called Rick Rule, one of the world's most successful resource investors.

Rick isn't some ivory tower economist... far from it. He's a fund manager. But he prefers to call himself a pawnbroker. Successful pawnbrokers and resource investors both have to know when something is cheap enough to buy.

But before we know whether copper is cheap enough to buy, we have to understand why it fell in the first place...

The copper price fell because of a collapse in credit.

Smelters and fabricators, who buy the majority of copper, don't use petty cash to make the purchases. A bank lends them money. When the smelter sells the finished products, it pays off the loan.

Traditionally, European banks provided financing to the base metal industry. But as you may know, European banks are in deep trouble right now. The banks can't lend money they don't have. With no available credit, smelters can't buy copper. The lack of demand for copper sent the price plummeting.

This is a short-term issue.

We can't do without copper stuff for long. As my colleague Brian Hunt likes to say, copper is in everything: home wiring, plumbing, cars, electronics, refrigerators, you name it. Once the banking crisis eases, smelters will begin buying copper again and the spot price will rise.

In the meantime, other bank troubles could actually put a floor under copper prices. Right now, banks are unwilling to fund mine construction. (That's true for all the base metals, not just copper.) If the industry can't finance new mines, we will run into supply constraints down the road.

In short, this collapse in the copper price shouldn't go much farther. And I expect we'll see higher prices down the road.

But Rick isn't buying yet. He's anticipating some lower prices in the near future. "I'm waiting for a moment of absolute pessimism," he told me. "And that hasn't come yet."

Since its bottom early this month, copper has recovered more than 8%. And investors have jumped right back in. The sector will need to drain out some of that optimism before Rick begins to buy again.