In their earnings release yesterday,Caterpillar (CAT) offered insight into the demand mining companies had for their heavy equipment. After reporting that results beat estimates, the company said that gold miners were "cautiously optimistic," but that copper miners are showing "significant caution" and would need to see stabilization in prices at or above current levels before they began to invest more. Caterpillar shares rallied sharply, but what are their customers seeing?
Earnings from leading mining company Freeport McMoRan (FCX) offer insight into metals prices and how miners are adjusted to the macro environment. The company reported profits of $588 million, or $1.38 per share, double the average analyst estimate. The mining giant increased production of copper and gold to offset falling unit prices. Some of that production comes from the Tenke Fungurume project in the Democratic Republic of Congo, a prized possession of Freeport's that just came online after extensive investment. Operating cash flow during the quarter was $1.2 billion, part of which allowed Freeport to redeem $340 million in debt prematurely.
Freeport's production results were greatly helped by shifting mining activity into a part of their Grasberg mine with more favorable characteristics, leading to 837,000 ounces of gold mined at very favorable prices. Copper prices, which bottomed in late 2008 at $1.25/lb., have recovered to almost $2.50/lb. compared to a peak near $4.00/lb. Gold prices, on the other hand, have remained elevated above $900/oz.
In constructing estimates for profitability the remainder of the year, Freeport used two targets -- $2.25/lb. for copper and $900/oz. for gold -- below current market prices. Primarily being a copper producer, management focuses foremost on the market dynamics for that metal, with CEO Richard Adkerson explaining, "To build infrastructure, to expand economies requires copper. We are certainly seeing that in China, as China has been doing that. And it's in the context of a very tight market... inventories of consumers around the world are very, very tight and even in the United States where market conditions remain weak."
Indeed, hopes for improved metals pricing largely hinges on emerging market demand; later in the call Adkerson responded to an analyst question about future copper prices by saying, "price is really driven by China and there is obviously risk in the Chinese situation depending on their buying patterns, et cetera." Shares of Freeport are up 6% this week.
The importance of China in the demand equation should raise serious questions about the sustainability of Chinese growth. For all the attention paid to Chinese superiority in manufacturing, the demand driver for that -- namely, American consumption -- is down sharply. How China will continue to grow without a strong market for its export goods is unclear, and will likely come down to the willingness of their government to invest in infrastructure projects, whether they are economic or not. Be careful of industries or companies that depend on China, which has not proven it can make the transition to self-sufficient economy without artificially foreign high demand for their goods.
James Cullen edits and writes at CollegeAnalysts.com. He has no personal position in the stocks mentioned above.