Are Copper Stocks Worth The Risk?

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March 15, 2016 12:34pm NASDAQ:CU

copperBob Ciura:  When it comes to precious metals like copper, all the news seems bad. The price of copper has plunged over the past year, but surprisingly, copper has staged a stealth rally in recent weeks. The price of copper is up about 5% since the start of the year.

While that hardly seems like cause for celebration, it’s at least a promising sign that copper has managed to stop the bleeding.

copper stocks

What about copper stocks? Whether investors should take all this as a cue that copper is back   ̶   and buy the major mining stocks like Freeport McMoRan (NYSE:FCX) and BHP Billiton (NYSE:BHP)   ̶   is far less certain. These stocks are extremely volatile and their fundamentals have collapsed along with commodity prices.

These stocks could provide massive gains, but they are very risky bets. Only investors with high levels of risk tolerances should even consider buying these stocks.

Copper Stocks: Only for the Brave

The commodity crash has affected a number of industrial and agricultural commodities, not just oil and gas. Precious metals like copper have been among the hardest-hit commodities over the past year. The prospect of higher interest rates, along with fears of slowing economic growth in critical emerging markets like China, walloped the price of copper.

This has weighed heavily on copper miners. Freeport lost $12 billion last year alone, as its average realized copper price fell another 22% in 2015. Even worse, the company has a bloated balance sheet, after several huge acquisitions of oil and gas companies. Investors likely recall that in 2013, Freeport acquired Plains Exploration & Production and McMoRan Exploration for $19 billion.

These massive deals saddled Freeport with a mountain of debt that is it struggling to repay. At the end of last quarter, Freeport still held $19 billion in long-term debt, and just $224 million in cash.

With nowhere to hide and a huge debt load, Freeport had to suspend its dividend in December to save cash.

Similarly, the crash in commodity prices has strained BHP’s financial health. Last fiscal year, BHP’s revenue declined 22% and earnings declined 86%, year over year. Through the first half of fiscal 2016, the company lost more than $5 billion, its first loss in more than 16 years.

BHP’s financial trouble forced the company to reverse its long-standing dividend policy. For many years, BHP had a stated corporate policy to pay a steady or higher dividend at each half-year reporting period. It called this a progressive dividend policy.

But this crisis is different than anything BHP Billiton has faced before, and the company had little choice but to slash its payout by 75% last month. This was the first time BHP Billiton cut its dividend in 15 years.

Sentiment Improves, But For How Long?

In recent weeks, sentiment around copper has strengthened slightly. A recent report from International Copper Study Group showing the copper market would see a small deficit of 56,000 tonnes this year. That could spur hopes of higher industrial demand than initially projected, which would be huge for copper.

The biggest area of focus should be China, which itself accounts for roughly half the world’s total copper demand, estimated at roughly 22 million tonnes per year. Economic growth there is feared to fall to multi-year lows this year, after lower-than-normal growth last year.

Copper has had an impressive rally off its lows, but over the past year it is still down significantly. Copper stocks have followed suit. They are in perilous financial condition, and many have slashed or suspended dividends to stay afloat.

Copper stocks have rocketed higher in recent weeks, which could signal a turnaround. As the saying goes, high risk sometimes means high reward. But whether that turnaround is for real is for gamblers to decide. If the price of copper keeps rallying, so will these stocks. Investors should only consider buying them if they have a heightened appetite for risk.

This article is brought to you courtesy of Bob Ciura from Wyatt Research.

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