Gold and Copper News Won't Be Good If Stimulus Is Cut

March 03, 2011

By Gerry Greer

What happens if QE2 stops and does not become QE3? My expectation is that growth in the US will come to a standstill, down from the 2010 fourth quarter annual rate of 2.8%. The recession will quickly take a double dip. I look to 2008 to see what lies ahead if the plug is pulled on spending.

Gold, and its most liquid ETF SPDR Gold Trust (GLD), was at a high of $1011.75 in March of 2008. The metal fell to $712.50 in October-- a 30% drop in 6 months. The iPath Dow Jones-UBS Copper Subindex Total Return ETN (JJC), First Trust ISE Global Copper Index ETF (CU) andCopper continued to make advances until July of 2008 when the markets fell and copper prices dropped from $408 per metric ton to $125.50 in December. This descent was a 70% drop. Is it any wonder that base and precious metals mining stocks are not participating in the recent increases in copper and gold prices?

The S&P 500 (^GSPC, SPY) took a 50% haircut in the same July to October period. The S&P’s peak was in May of 2008. If the economic stimulus continues, modest growth will follow and unemployment will drift lower. However, the end of stimulus will be the end of the American economy for a very long time. If you believe the stimulus is over I suggest you fold all tents and move to cash, noting that the US Dollar (USD) is also falling rapidly, but may not exceed the expected 30% drop for gold.

Ben Bernanke is an expert on the Great Depression, the fall of 1929, the double dip of 1937 and the massive spending of the Second World War. It is the unimaginable size of the massive spending during the war, which ended the Depression. The war utilized all the labor and resources of the world. Ingenuity created new technologies gave birth to the space age and the atomic era. The Fed is currently mopping up government spending. Spending, that had little planned economic focus. A Republican Congress somehow feels that austerity is going to get America going again with no direction and will do it in a timely fashion though, no time table is ever given.

The reality is America can utilize its youth on the battlefield or employ its youth. The US can consume the world’s resources, on a battlefield, or it can join Asia in building infrastructure and creating jobs. It can spend money healing the wounded or creating a healthcare system for all. It can spend it on creating the necessary innovation of war or on educating its people and getting them a seat on the best campuses in the world, right at home. Restoring the public primary and secondary school system to number one in the world is a worthwhile goal.

To accomplish it all there will have to be a tax system, which collects revenue from sources at hand. That means the wealthy and corporations with profit. There will have to be a consumption tax on all. Spending cuts will also have to occur. If the current government decides to wallow along and not tax where there is revenue potential, and not cut spending in areas where nothing of significance is being accomplished, America will not recover. Politicians are now in a position where they will be forced to think as if they are at war. Politicians do not like to think, especially about tough choices.

The biggest goal of the government right now has to be job creation. Corporations that create jobs deserve a tax break; individuals who create jobs deserve a tax break, new entrepreneurs who create jobs deserve tax breaks and financing to get going. Giving tax breaks to all with nothing in return will not work. We are now witnessing the effect of a little bit of trickle down; insufficient job growth.

Every corporation and individual has a current base payroll and number of employees. It is not difficult to establish a tax credit based on the expansion of those base numbers. Create a job and you great a tax break. Create lots of jobs and you get even a bigger break. Allow the tax credits to be carried forward. Throwing out wholesale tax breaks has cost America not billions but trillions over the last decade. Praying for a Regan style trickle down job creation, and not leakage spending on widgets from China or a trip to the Caribbean is beyond silly; every businessperson understands the need for long term focus and planning. The politicians in China have this understanding and follow through on it.

Hopefully the political machine in America will treat job creation like a conflict of war.

Should Americas enter this conflict with any sense of determination, copper and those producing copper will be winners. For those that only see quantitative easing leading inflation, and its absence leading to a depression with currency destruction, gold may be a relative winner.

Here is our opinion on leading metals producers:

Freeport-McMoRan Copper & Gold Inc. (FCX) is the world’s largest publicly traded copper company. It is also the world’s leading producer of molybdenum. Freeport-McMoRan Copper & Gold Inc. has reserves of 40 million ounces of gold. FCX split 2 for 1 on February 1, 2011. Its dividends have varied year to year with last year yielding about 1.9%. Its goal is to maximize shareholder value through cash dividends and share repurchasing. There is speculation that FCX will enter into the bidding for Toronto-based LUNDIN Mining Corporation.

Freeport-McMoRan Copper & Gold Inc has reserves of approximately 120 billion pounds of copper, 40 million ounces of gold, 266 million ounces of silver and 2.48 billion pounds of molybdenum. The current cash cost is approximately $1.10 per lb. of copper based on $1350 for gold and $15 for molybdenum. Cash costs will vary by about $.02/lb with every $50 change in gold or $2 change in molybdenum.

FCX currently trades at 11.5 times earnings, and the median for analysts is a target price of $65 for 2011. This is about a 30% increase from its price level.FCX has a market cap of 49 billion. FCX is the granddaddy of copper and has the cash. At the end of 2010 FCX had 3.1 billion in cash; the company declared a special dividend of $.25 and has just retired 1.1 billion in debt. The 8.25% notes were not due until 2015; early retirement will save 90 million in interest expense per year. There will be a loss in the first quarter of 2011 due the retirement of this debt. Cash flows in 2011 are expected to be about $8 billion.

What are the possible North American targets of the cash rich large miners?

Northern Dynasty Minerals Ltd.(NAK) has just received its preliminary technical report on its Pebble copper gold molybdenum project in Alaska. Anglo American (AAUKY.PK) the largest miner in the world purchased half of the project by agreeing to a staged investment of $1.425 to $1.5 billion. NAK currently has a market cap of $1.64 billion. The property hosts 55 billion lbs of copper in the measured and indicated categories, as well as 25.6 billion lbs in the inferred category; 66.9 million ounces of gold in the measured and indicated categories and another 40.4 million ounces of gold in the inferred category. There are 3.3 billion lbs of molybdenum in the measured and indicated and 2.3 million lbs in the inferred category. The initial capital investment is expected to be 3.6 billion. Mitsubishi Corporation (MSBHY.PK) has reported they have acquired an 11% share position of NAK and Rio Tinto (RIO) has a 19.8% share position. I currently do not have a position in NAK, however I buy and sell this stock on technical’s; with a strong in ground mineral position and financially strong shareholders and partners, when this stock goes oversold, and it does, becoming the fly on the elephant’s back for a ride up is easy to take.

In the Yukon, Western Copper Corporation (WRN) is currently updating its Pre-Feasibility Study, on its flagship property Casino, per a new release in January 2011. WRN has a market cap of 334 million with 102.6 million shares outstanding on a fully diluted basis. Casino hosts 8.5 million ounces of gold in the Measured and indicated categories and a further 8.8 million ounces in the inferred category. The property has 4.6 billion pounds of copper in the measured and indicated category and 5.4 billion pounds in the inferred category. There are 527 million pound of molybdenum in the measured and indicated categories and 720 million pounds in the inferred. The new resource update scheduled to be released in the first quarter of 2011 (by the end of this month) will also include the silver findings on the property. The current estimate for the initial capital cost is $2.1 billion. The new study will take into account so new efficiencies, and it is hoped the current initial capital investment required will be reduced. At today’s spot prices the payback is 2.5 years and the mine life is 30 years. At even $.10 lb for the copper this company is extremely undervalued.

In British Columbia a small very speculative play that I like is Serengeti Resources Inc. - (TSX-V:SIR)(Frankfurt:34S) SIR has a market cap of $17.4 million and 51 million shares outstanding on a fully diluted basis. SIR is actively looking for partners or buyers of its Kwanika property in north central BC. The property contains an indicated mineral resource of 1.2 billion pounds of copper, 1.6 million ounces of gold and 5.4 million ounces of silver.In the inferred category there are 1.25 billion pounds of copper and .91 million ounces of gold.

Set price targets for takeovers based on recent conservative takeovers. Thompson Creek Metals Company (TC) recently purchased Terrain Metals Corp. for approximately $700 million. The Mt. Milligan property contained 2.1 billion lbs of copper in the proven and probable reserve category and an additional 711 million lbs in the measured and indicated category. There are 6 million ounces of gold in the proven and probable categories and 1.5 million in the measured and indicated category.

If the US works at getting its economic house in some sort of balanced order, and that means revenue sourcing as well as focused spending cuts, the outlook for world resource industries is very bright. If it does not I would be very cautious on even gold saving anyone from financial malaise.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLD over the next 72 hours.

Additional disclosure: Disclosure, I currently hold both WRN and SIR.