For some time now, investors who wanted to share in the gains of copper could do so by buying one of its pre-eminent miners, Freeport-McMoRan Copper & Gold Inc., since its stock exhibited a high correlation with the price of the red metal.
Here's my bold prediction for 2013: That relationship is going to break down, so investors who want a copper-driven equity must search for alternatives.
Actually, this one's a pretty easy call, given Freeport's widely derided announcement last week of its plans to diversify its business line away from mining with the purchase of two energy companies.
Pretty much everything about the deal is wrong: Freeport, worth $36-billion (U.S.) before the deal was announced, will pay about $20-billion to add energy businesses that will contribute only about one-quarter of the company's profits in 2013. It's paying significant premiums for the two companies, both of which have significant operations in the risky business of deep-water drilling.
Both of the companies have corporate connections to Freeport; one, called McMoRan Exploration, was actually a Freeport spinoff nearly two decades ago. The overlapping board members stand to make tens of millions of dollars in profits from their holdings. And Freeport structured the deal so its own shareholders won't be able to vote on the transaction.
It could be the worst merger of the year. It could be the worst merger of the decade. (For even more, look up journalist Jim Jubak's "Why the Freeport-McMoRan Deal Stinks" on the MSNMoney website; he removed the company's stock from his "Jubak's Picks" portfolio on news of the deal.)
Freeport explains the deal as giving it "exposure to energy markets with positive fundamentals, strong margins and cash flows, exploration leverage and financially attractive long-term investment opportunities." And it plans to use cheap debt, rather than new equity, to finance the bulk of it, enabling current shareholders "to retain the significant value we see in our existing asset base."
Of course, as I've said in other contexts, Freeport shareholders can get exposure to energy markets by buying the shares of other companies themselves. What they liked about Freeport was its high correlation with copper prices – 90 per cent over the last three years, notes analyst George Topping of Stifel, Nicolaus & Co. Inc.
Well, now what? Some other big mining names with copper operations exhibit strong correlations to the underlying spot price, according to Mr. Topping's research. Teck Resources Ltd. and BHP Billiton Ltd. have shown the correlation trend over the past three years, while two smaller concerns on the TSX – HudBay Minerals Inc. and Capstone Mining Corp. – have some of the strongest correlations over the last three months, he said.
The Freeport deal prompted the metals and mining analysts at Macquarie Equities Research to ask, "Will the real copper pure plays please stand up?" And the list of "upstream copper-dominated equities" they compiled requires a taste for investing all across the globe.
Closest to home, Macquarie names the TSX-listed First Quantum Minerals Ltd., with its operations primarily in Africa, and the NYSE-listed Southern Copper Co. headquartered in Freeport's home city of Phoenix, Ariz., but with operations in Mexico and South America.
Macquarie also includes PanAust Ltd., a Southeast Asian miner based in Australia and trading on that country's exchange; Polish concern KGHM Polska Miedz Spolka Akcyjna, on the Warsaw Stock Exchange, and Kazakhmys PLC, a British company that focuses on Kazakhstan.
Of particular interest: Macquarie suggests U.K.-based Chilean miner Antofagasta PLC, and Southern Copper Co. "stand out as the two 'cleanest' equity plays on copper," given the metal provides more than 90 per cent of each company's earnings.
Antofagasta is "the safety play," Macquarie says, since it has $2-billion in net cash, peer-leading margins and is one of the least volatile stocks in the group. It's priced at a 30 per cent premium to the sector – but traded at premiums of 52 per cent and 42 per cent at times in 2012, Macquarie notes.
And, there's always an exchange-traded note; in this case, it's the iPath Dow Jones-UBS Copper Total Return Sub-Index (JJC), the only copper ETN with more than $100-million in assets. There's at least one advantage to picking an ETF over a mining equity: Management of the fund won't suddenly decide it needs to make an expensive, distracting foray into oil and gas.