Metal stocks that can make you some coin

By Conor McCreery
Globe Investor Magazine Online, May 28, 2008

For a long while it seemed that precious metals were ruling the resource roost. Gold shot up to record highs and platinum and palladium also experienced prodigious gains. But those three metals have all fallen back to earth over the past three months. Fortunately, all that glitters isn't necessarily gold.

While fears of a global slowdown have turned many investors away from nickel, lead and zinc, some base-metals are still showing strength. "There is a big supply-side story on copper" says Annie Sorich, lead equity analyst at Morningstar. "Mines are having trouble expanding. There are labour, permitting, and power issues [around the globe]."

Those supply worries have pushed copper up some 17 per cent in the past half a year. Compare that to the 31-per-cent decrease in lead's spot price, nickel's 20-per-cent haircut and an almost 40-per-cent decline in zinc and it's clear that copper is operating in a different space than many of its metallic kin.

Copper isn't the only base metal attracting investor attention. Iron ore and the three giants that mine the product -Companhia Vale do Rio Doce of Brazil, BHP Billiton Ltd. of Australia and Rio Tinto PLC of Britain - have also caught more than one fund manager's eye. Those three dominate the market for the metal used to make steel, giving them huge influence in pricing.

Benoît Gervais, portfolio manager at MacKenzie Financial, says he'd rather "pay up the multiple" for firms with pricing-power in this market. "We're in the second-half of the resource cycle and the rules have changed. You can't just buy any decent company and ride the [commodity's] price increase."

So how can you play copper and iron ore? Here are five suggestions from the pros.

1. Vale (RIO-NYSE).

Ms. Sorich considers this Brazilian giant the best in breed of the mega miners.

"They have the best iron-ore [assets] in the world, hands down," she says, noting Vale is also a low-cost producer. The Morningstar analyst also believes the value of iron-ore contracts are poised to take a big jump. That's because Vale rivals BHP, and Rio Tinto are in the midst of negotiating new contracts with China. Ms. Sorich expects a price gain, partly because China recently showed a willingness to pay up for commodities when it agreed to a big increase in the price of potash, and in part because the limited spot market for iron ore shows prices close to double the current long-term rate.

Ms. Sorich also likes Vale because it has more exposure to copper than its rivals. Conversely, Mr. Gervais likes Vale because of it's limited exposure to zinc. He's held Vale, which acquired Inco Ltd. in 2006, in his funds for seven years and has no intention of getting out now. "We think the bull market on commodities will be over when companies like CVRD are trading at Standard and Poor 500 type multiples." Right now CVRD is trading at 10 times forward earnings (based on Bloomberg estimates), the S&P 500 is trading at just under 13 times.

2. Labrador Iron-Ore Royalty Income Fund (LIF.UN-TSX).

This is another stock Mr. Gervais believes is trading cheaply, calling it the "most reasonable" Canadian play on iron ore. Like Vale, Labrador is also selling at roughly 10 times forward P/E. It co-owns a mine in Quebec, Carol Lake, with giant Rio-Tinto. Mr. Gervais calls Carol Lake a "quality deposit in a high quality industry." And even though Labrador Iron-Ore isn't a big player, it still has reaped the benefits of large price increases. German firm ThyssenKrupp recently agreed to 87- and 69-per-cent price hikes for Carol Lake's two main products, iron ore and iron pellets, respectively.

3. Freeport McMoRan (FCX-NYSE).

Copper is Ms. Sorich's favourite play among base metals right now and the world's largest publicly traded copper company is her favourite way to get some skin in the game. She expects copper to climb to just under $7,800 (U.S.) a tonne this year - giving it another 10-per cent to run.

Ms. Sorich likes Freeport because its key mine, located in Indonesia, is the world's lowest-cost producing copper property and now that the company has bought Phelps Dodge it has some much needed diversity.

"They aren't nearly as vulnerable to a flood or political instability in Indonesia as they once were," she said, adding that she is excited about Freeport's work on the Tenke Fungurume project in the Democratic Republic of Congo. "It has the potential to be a huge mega-mine. It could potentially be the biggest in the world."

Freeport is also the globe's biggest producer of molybdenum, another metal Ms. Sorich thinks has a great deal of potential to rise in price. Ms. Sorich recommends investors wait for the next pullback on the New York Stock Exchange and use it as an entry point. She has a "fair-value" calculation for FCX of between $103 and $154 a share. It is currently trading at about $117.

4. Taseko Mines (TKO-TSX) and Imperial Metals (III-TSX).

These two Canadian copper juniors are both picks of Robert Cameron, an analyst at Research Capital and former Canadian exploration manager at Freeport McMoRan. He prefers Taseko and Imperial to other plays because of their limited exposure to political risk. "Sovereign risk is my No. 1 thing to avoid in the copper market."

Mr. Cameron is particularly concerned about on-going power issues that have plagued much of Africa - a continent where many juniors are toiling. Instead, he prefers Taseko and Imperial, which have producing mines close to each other in British Columbia. "They're getting the benefit of high copper prices right now," he says. He calls both firms efficient little operators, and he also likes Taseko for its additional exposure to molybdenum.

5. Allegheny Technologies (ATI-NYSE).

"It's a one-stop shop for advanced alloys" says Mr. Gervais of the Pittsburgh-based company best known for its titanium. "It's a growth stock with a value multiple." Allegheny is currently trading at a forward P/E of just under 9.5. Over the past three years, the company has increased both earnings and revenue by double digits. It also pays a small dividend. But for Mr. Gervais the appeal here is a chance to be part of the future. Allegheny's stock-in-trade is developing the space-age materials he feels will be the staple of industry in years to come.

He especially likes the potential of titanium to replace aluminum. "It's more expensive to use titanium, but with energy prices skyrocketing, airlines will more than make it up on fuel efficiency and weight." ATI has struggled of late, losing 35-per cent of its value since last October. But Mr. Gervais stresses he's a long-term investor and he has faith in the company and the sector-he also holds lesser amounts of several of ATI's competitors.