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Benefits from a Soft Landing

Richard Croft
February 5, 2012
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4 minutes read
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Commodities, especially metals, hit a soft patch late in 2011. The concern among analysts was weak demand coming from the emerging markets… specifically China. But sentiment is beginning to change. All because China, the world’s largest commodity gobbler, seems headed for a “soft” landing rather than the “hard” fall that analysts were expecting less than a quarter ago. Makes you wonder how much the so-called experts really know.

In the end, it all comes down to the numbers. In the early part of 2011, the Chinese economy was experiencing the kind of robust growth that sparked a speculative bubble in the US ultimately leading to the crash precipitated by the sub-prime meltdown. But unlike the US, China’s emphasis on central planning, controlled enough of the economic levers that many now believe it can manage the intensity of any slowdown. And so the numbers have changed!

We note for example, that China’s official manufacturing index rose to 50.5 in January, up slightly from the 50.3 reading in December. A small improvement to be sure, but moving in the right direction. Probably the better indicator is the more accurate HSBC / Markit PMI reading. But here too the numbers were going up although at 48.8, it is still below the growth threshold of 50.

Export, import, and employment indexes all showed declines within the PMI, implying a growing probability of a slowdown that will shrink Chinese growth to slightly above an annual 7% clip for 2012. In turn, China’s monetary policy is likely to become more accommodative in the months ahead, in an effort to support growth and prevent a complete collapse of, by all accounts, a real estate market that borders on speculative excess.

All of this is adding up to a brighter outlook for base metals, particularly copper. Note that copper climbed to US $3.43 per pound in December and surged to US $3.91 by late January, as Chinese imports rose to a record in December, up 78% year over year. That’s good news for the world’s copper miners, as the global supply of copper remains in a deficit position, and mine output is expected to grow only 5% this year.

It is also potentially good news for aggressive option traders. Especially those who buy into the China soft landing scenario and are looking for opportunistic plays in the commodity sector. Particularly one could look at some of Canada’s major copper producers, whose share prices have dipped recently.

For example, Copper Mountain Mining Corp. (TSX: CUM, Friday’s close $5.45), which recently warned of lower-grade copper output at its BC Copper Mountain mine in 2012. With only 0.35% copper expected, compared with previous estimates of 0.45%, the company is now expected to produce about 85 million to 95 million pounds this year, still considerable, and still profitable, even if costs of production rise slightly. The low grade production estimates resulted in a sharp selloff in late January, with CUM shares falling to $5.16 from a high of $6.36 earlier in the month. Which means that trading in CUM, while still a major Canadian copper producer, will be the more speculative trade in this space.

The other major Canadian players are Teck Cominco (TSX: TCK.B, Friday’s close $43.40) and First Quantum Minerals Ltd. (TSX: FM, Friday’s close $23.43). All three should find short-term share-price support from the continuing shortage in world copper supply.

With that in mind, aggressive traders might look at buying medium term call options. With CUM, look at buying the July 5 calls at $1.10 or better. For TCK.B, the Aug 45 calls at $3.70 look interesting. And finally with FM, consider the July 25 calls at $2.70.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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