Email – #461

By the end of this year we’ll either see the economy turn up… or not. There is far too much money being pumped into the system for “nothing” to happen.

Best Case Scenari We’re off to the races.

Worst Case Scenari We’re in a Depression, not a recession.

If we’re headed for even greater financial catastrophe, you’ll want to be in gold – we have Yamana in our portfolio and the shares are doing quite nicely. But if there is a recovery, you’ll want to be in a commodity stock that will rally with any recovery. The most leveraged commodity tied to the economy, apart from oil is copper. Copper has been trashed in the past 12 months, falling more than 66% from the highs as housing and autos collapsed.

Yesterday the Leading Economic Indicators were released. If you believe the numbers – which were positive – then we should begin to see a turn in the next six to nine months. The LEI takes into account many factors from money supply to consumer sentiment. It’s a good gauge for future economic activity and has been trending down every month for a while… until yesterday.

Copper And Gold: A Match Made For Profits

Today we’re going to hitch our wagon to a company that has made us money before. Last time we made money on this play, it was trading at $65 and on its way to $125. Today, it is at $25. But, just like then, the options are really expensive and requires us to use a bull spread to make it work for us.

If you recall, a bull spread is when we buy a lower priced option and sell a higher priced option against it. The benefit is a lower cost, but we also limit our upside. In this case we’ll spend about $5 to make $20 if it works for us.

The company is Freeport Copper and Gold (NYSE: FCX). FCX gives us exposure to copper and gold. The shares have plummeted as the copper component trumped the gold component of the shares. And rightly so, since FCX makes more money from copper than gold, though it has substantial gold operations as well.

When it bought Phelps Dodge a couple of years ago, the company became overweight in copper, and at the right time too. It’s earnings soared during the boom. But now the company is paying the price for being overweight!

FCX has extremely strong and smart management that understands the need for sound finances. They recently cut their dividend, took massive non-cash charges related to the goodwill from the Phelps Dodge acquisition, and wrote down the value of inventories. The shares reacted nicely to both moves, initially falling after the dividend cut last quarter only to rise sharply in the following days.

If we do have signs of a recovery in the next 12 to 18 months, shares of FCX will soar in price as it’s extremely leveraged to economic growth. We could easily see the shares trading up $30 to $40 higher than current levels.

Here’s the play:

• Buy the FXC January 2011 $30 calls (OBQ AF) currently trading for $9.35.
• Against this, sell the FCX January 2011 $50 call options (OBQ AJ) currently trading at $4.35.
• Your net cost based on current prices will be about $5, or about 20% of the current share price. Use $5 as your maximum price for the spread (the difference between what you pay for the $30 call option and what you receive from the sale of the $50 call option). The market is volatile, and this stock is VERY volatile… so let the price come to you.

In other news, our US Steel Options are looking even better after the company reported better than expected numbers today. We have a long time on this one and it is also a commodity play tied to a future recovery and an infrastructure play as well.

Karim