Copper Oversold?

Caught in last week’s bout of risk-aversion was the entire commodity complex. Copper and oil, two of the most economically sensitive materials, sold off dramatically as traders reacted to growing fears of declining overseas growth.

A slowdown in China was of particular concern as was the market’s disappointment that the US Federal Reserve Board decided not to engage in another round of quantitative easing. Instead, the Fed decided to re-jig the maturities in its Treasury asset holdings, specifically buying longer term treasuries with capital the sale of and maturing of shorter term maturities.

Despite the sound and fury thundering over markets, it may be that the reports of a recession have been greatly exaggerated. Slowdown in the pace of growth, certainly. Contraction everywhere, however, is not a certainty by any means.

Perhaps in the eurozone as a whole, but stronger member countries like France and Germany may avoid recession. China appears to be heading towards a slowdown in the pace of growth, but a slide from an annual GDP growth rate of 9.5% to 9% hardly seems “recessionary.” Likewise, the US appears unlikely to slip into recession, although the pace of growth may slow to a crawl. And given political stalemates at every turn, GDP growth will likely remain moribund for some time to come.

Demand for copper isn’t likely to evaporate according to recent forecasts by Goldman Sachs. If they are right, the supply / demand situation should provide some support for copper’s price.

Bold options investors might consider a speculation on the recovery in the price of copper, and consequently in shares of mining companies that may have become oversold in last week’s panic. Bullish positions in solid copper players like Copper Mountain Mining Corp. (TSX: CUM, Friday’s close; $4.71) and Quadra FNX Mining Ltd. (TSX: QUX, $9.36) will bear fruit if the forecasts prove correct.

Given the high premiums currently available on the options, I would look to covered call or naked put strategies. For example, with CUM, you could buy the stock at $4.71 and write the January 5 calls at 70 cents. Assuming you get filled at these prices, your three month return if exercised is 24.6%. If the stock remains unchanged your return is 17.5%. And your are protected on the downside to $4.01 per share.

With QUX, buy the shares at $9.36 and write the January 10 calls at $1.00. The return if exercised is 19.6% while the return if unchanged is 11.9%. Downside protection is at $8.36 per share.
In both cases, you could also sell naked puts. For example, with CUM, sell the January 5 puts at $1.00 and with QUX write the January 9 puts at $1.05. The sale of the puts obligates you to buy the shares at the strike price of the put.

If you are assigned on the CUM puts, you would be required to buy the shares at $5.00 per share, but given the $1.00 premium received, your net cost would be $4.00 per share. Similarly with QUX, your cost to buy the shares is $9.00, but with the premium received from the sale of the put, your net out of pocket cost would be $7.95 per share.