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Gold & silver prices get all the ink,...but is copper a better gauge of what is going on?

• moneycentral.msn.com
 
Anthony Mirhaydari: What 'Dr. Copper' says about the economy
Extra5/19/2010 4:02 PM ET What 'Dr. Copper' says about the economy

Most eyes are on gold right now, but copper gives us a better read on the economy and a better way to play the recovery.

By Anthony Mirhaydari
MSN Money

Gold has been getting all the attention lately, rocketing to new highs as fears over European debt have grown to fever pitch. But many Wall Street insiders have been preoccupied with the vagaries of another, less-glamorous metal: copper.

After rising 193% from its 2008 low, the red metal had fallen 21% through May 17. And after a deep sell-off that day, copper futures dropped under their 200-day moving average for the first time since summer 2008 -- a critical line of demarcation that normally marks the transition from bull market to bear market.

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Whereas gold is seen as a store of value and a hedge against economic Armageddon, what some call "Dr. Copper" is said to be the metal with a Ph.D. in economics for its ability to presage the future of the global economy. Copper turned higher in 2003 as the economy recovered from the 2001 downturn. It turned lower in 2008 as the credit crisis was getting started. And the metal started moving higher in the last days of 2008, three months before things turned around for the stock market.

After such a steep fall, many began to wonder if the metallic professor is warning of trouble. Fortunately, this doesn't appear to be the case. The current slide appears to be a temporary setback, presenting those on the sidelines with a chance to get in on the action.

Predicting growth (and playing it) According to industry experts, copper is headed for a significant supply deficit over the next few years, which should keep prices elevated.

 

In fact, copper could be the metal of choice for investors looking to add some commodity exposure to their portfolio over the next few years. While gold has limited uses apart from jewelry, copper is critical to the manufacturing of electronics, homes and infrastructure. It's in your walls, your plumbing and your tech toys, not to mention pennies. (Well, older pennies; since 1982, U.S. pennies have been made mostly of zinc, with just 2.5% copper.)

Copper prices, May 17, 2007-May 17, 2010 © StockCharts.com

 

Copper's ubiquity gives it its unique economic predictive power. And it makes the metal one of the strongest plays on a growing economy.

The truth is, it's becoming harder and more expensive to find and mine copper, just as global demand is set to swell.

Why production costs are higher A recent research report from Merrill Lynch explored the structural problems faced by the copper industry. Since 2006, the copper-concentrates market has seen a net supply deficit. That's why copper trades well above production costs.

 

Normally, high commodity prices cure themselves, because they encourage new production and an increase in supply. But with copper, a decline in the quality of ore coming out of existing mines has been a limiting factor. After moving higher throughout the 1990s and 2000s, industry ore quality has fallen to levels not seen since the mid-1980s.

As an example of this, BHP Billiton (BHP, news, msgs) recently reported that its Escondida mine, in Chile, will produce less copper this year and next as falling ore grades weigh on output.

 

This has increased production costs as miners are forced to move more dirt to extract the same amount of ore. What's worse, an increasing percentage of new projects is in less-established countries such as Mongolia. This increases the costs of production and the risks associated with capital expenditures.

And even as new mines start production, ore quality isn't expected to improve. In fact, average ore quality could actually decline. New projects in Chile, Peru and elsewhere are expected to produce ore of lower quality than the current average grade. The Merrill Lynch researchers believe these factors will continue to support copper prices over the medium term. They expect prices to increase from just above $6,000 a ton recently to $6,613 by the end of the year and near $7,300 sometime in 2011.

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