Name That Trade – $FCX: Copper Topped

by Enis July 24, 2014 12:36 pm • Commentary

FCX was downgraded by the Bank of America analyst this morning, and the stock has broken its $38 breakout level in trading today.  I discussed the importance of the $38 level in a CotD post at the start of July:

In one positive sign for FCX shares, the stock has been outperforming the commodity for the past year, as investors are showing more confidence in owning FCX rather than copper itself.  While the correlation between FCX and copper is obvious on the weekly chart of FCX below, the stock is now near a new 18 month high, while copper prices are still more than 15% away from a similar milestone:

FCX weekly chart, Courtesy of Bloomberg

FCX’s outperformance vs. the underlying commodity is part of a broader outperformance by miners over the 6 months, relative to the moves in the underlying commodities.

FCX proceeded to gap above $38 in the next session, and had held above that level throughout July until today’s break lower:

FCX daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
FCX daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

So that’s clearly the level to watch this morning.  We discussed a similar technical situation in MON in yesterday’s Name That Trade post, where MON was retesting its breakout level of $117.50.  However, there is one main difference between FCX and MON on a fundamental basis.  

Whereas grains prices have been falling for the past couple of months and are now at multi-year lows, copper prices are near a 6 month high, and in an uptrend since the March lows:

[caption id="attachment_43344" align="aligncenter" width="600"]Copper futures second month contract, Courtesy of Bloomberg Copper futures second month contract, Courtesy of Bloomberg[/caption]

FCX is very tied to copper prices, and the uptrend over the past few months in metals in general would be quite encouraging for FCX earnings if it continued.

Moreover, Chinese economic data is starting to improve.  While we are still skeptical of the long run sustainability of China’s infrastructure and credit boom, the government has proven more than capable of offering acute injections of stimulus to goose spending from time to time.  Cam Hui laid out a good, nuanced case for some potential short-term strength amidst the long-term risks in China’s economy.  The Citigroup China Economic Surprise Index is positive for the first time since early in 2014, as economic data has improved:

[caption id="attachment_43345" align="aligncenter" width="600"]Citigroup Economic Surprise Index for China, Courtesy of Bloomberg Citigroup Economic Surprise Index for China, Courtesy of Bloomberg[/caption]

The likelihood that copper prices hold up is higher today than earlier this year given the more positive macroeconomic backdrop in China.

If copper prices remain at the current level or move higher in the coming months, FCX looks attractive on a fundamental basis.  The stock sports a 13.5x P/E with a 3.3% dividend yield and significant potential earnings growth (double digits per annum) if copper prices remain steady.  We have seen large moves in similarly valued, old story stocks in the tech sector (MSFT and INTC most notably) as investors have run out of reasonably valued companies to buy.

Finally, implied volatility in FCX remains near 2 year lows:

[caption id="attachment_43348" align="aligncenter" width="600"]FCX 30 day implied volatility, Courtesy of Bloomberg FCX 30 day implied volatility, Courtesy of Bloomberg[/caption]

At the moment, I want to see FCX regain the $38 breakout level.  If FCX can get back above $38 in the next week in a sign of technical strength, I am considering two possible bullish trades:

Hypothetical Trade #1:  FCX Buy the Nov 39 / 44 Call Spread for 1.00

-Buy 1 Nov 39 Call for 1.20

-Sell 1 Nov 44 Call at 0.20

Rationale:  Nov is the next expiration which captures late October earnings.  The cheap level of implied volatility means that the call spread will not decay much over the next couple of months if FCX remains around $38.


Hypothetical Trade #2:  FCX Trade the Nov 35 / 40 Risk Reversal for a $0.05 credit

-Sell 1 Nov 35 Put at 0.90

-Buy 1 Nov 40 Call for 0.85

Rationale:  This trade is also November expiration, but does not involve any premium outlay and is unlimited upside above $40, in compensation for taking full downside below $35.