Jubak: Thinking Long Range on Copper

NEW YORK ( Real Money) -- Now it's just a question of getting the timing right.

I think we've got a reasonably good read on the supply/demand picture for copper and on the rising costs/falling ore grades for copper.

It's not a pretty picture. Investors are looking at more budget cuts, lower production as ore grades fall, and falling copper prices for 2013 and 2014.

But they're also looking at the need for the industry to add 4 million metric tons of annual capacity by 2024 -- just to maintain 2012 levels of production.

If you know how the boom/bust/boom/bust mining industry works, today's copper surplus (and falling copper prices) will turn into a huge spike in copper prices at some point down the road when copper production doesn't meet demand because of cuts in capital spending in 2012, 2013 and 2014.

The question is when? And which copper stock would be the best buy for profit from that eventual spike?

My pick would be First Quantum Minerals (FM:Toronto) or a very thinly traded FQVLF:OTC.

First Quantum successfully completed an offer to acquire Inmet Mining (IMN:Toronto), another Canadian mining company. The big prize here is the massive Cobre Panama copper deposit, the second largest undeveloped copper deposit in the world.

Reserves at Cobre Panama have recently been upgraded to 26 billion pounds of copper and 7.3 million ounces of gold.

The mine will have an annual production capacity of 300,000 tons when the mine starts cooking.

It's the "when," though, that I think is most potentially profitable. At the end of 2012, the $6.2 billion Cobre Panama project was about 10% built according to Inmet. And the completion date is, probably, 2016, by my estimates.

That puts the mine's 300,000 tons of new production right in the middle of what strikes me as the period with the most potential for a spike in copper prices because of underinvestment in new capacity in 2012 to 2014.

However, 2016 is a long way away and there are plenty of potential potholes in this road. And that's precisely how I'd play First Quantum Minerals now.

Start a tracking position today with about 10% of whatever you think would be the size of your final position. I find that having some skin in the game focuses the attention mightily and this way you can go to shareholder meetings and call investor relations with questions. And if I'm wrong and copper recovers more quickly than I now expect, you'll make a profit on this position.

But what you really want to do is follow the news flow on this project as Cobre Panama moves toward startup. First Quantum's strengths are in engineering and construction and the company has argued that it will be able to cut at least $1 billion from Inmet's cost estimates by bringing much of the work in-house.

Great.

But even if it happens exactly as First Quantum projects, on a project this big there will be delays, cost over-runs, negative stories on construction progress.

Stuff goes wrong.

Starting next year, when I estimate that copper will be even more out of favor than now, you'll want to add to your First Quantum position whenever one of these bad news stories hits. (That's assuming you remain convinced that the project hasn't gone horribly wrong. If First Quantum hits a hole to the center of the earth and dinosaurs start pouring out, I'd sell.)

Your goal is to build up a full position by 2016 and to lower your basis price over and over again.

What you've bought is a kind of very long, undated option on the future production from Cobre Panama (and First Quantum's other expansion projects.) And you're trying to lower the cost of that long option as much as you can.

At the time of publication the author held no position in the stocks mentioned.