Freeport-McMoRan and the Mining Boom

Last week, PBCM bought Freeport-McMoRan (FCX) as a play on surging copper, silver and gold prices. While we won't divulge into our thesis here, Mark sent me an interesting article from the Financial Times on the mining and resource stock boom:

Mining

Published: October 21 2007 19:20

After being badly burnt by companies that made nothing, it is not surprising investors switched their allegiance to real assets when the dotcom bubble burst. What could be more real than stuff in the ground?

But seven years on, the incredible run in resource stocks has the look of a bubble itself. There is a near-universal bullishness, while some accuse sceptics of just not getting it. Mining sector bankers and commodity traders are in the ascendancy, much as their technology colleagues were in the 1990s. Retail investors are suddenly experts on nickel. In the same way that the internet was once an article of faith, investors now bow towards China.

The latest surge in resource stocks the sector has bounced more than 15 per cent since the 50 basis point rate cut in the US feels frothy. But the forward price/earnings ratio for the global metals and mining sector is still only 13 times. That is below the 10-year average of 15 times and well short of this decade's highs, when forward multiples hit 20 times. One reason why valuations pale beside the lunacy of the tech bubble is because company analysts are more conservative than commodity traders stock analysts' earnings estimates reflect commodity price forecasts as much as 40 per cent lower than prices in the commodity futures market.

Resource bulls argue that concerns about future supply are misplaced and that production problems will maintain upward pressure on everything from iron ore to copper. Indeed, one of the mysteries of the sector is why production growth has been so low, given that most metal prices are far above the levels required to justify investment. But even if that situation continues in the short term, it is a bad habit to extrapolate rising prices forever as new capacity is being built and one day China's growth will slow. Also common to all booms is the tendency to forget that even the most positive trends may already be discounted.