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Don't bet the farm on the mine
Commodity stocks like copper are through the roof -- but don't count on them staying there.
 LONDON (FORTUNE) - Like the teenagers who favored Benetton shirts and Jams shorts in the 1980s, individual investors can fall for fads whose appeal seems scarcely understandable after the fact. I'm not just talking about obvious examples like Pets.com, I'm referring to whole classes of investments - remember when ads on the radio said you just had to be in CMOs (collateralized mortgage obligations) or emerging markets or telcos? I do - and I remember the pain when those bets came a cropper.
Right now, there's a fierce debate going on in the markets over commodities, which have enjoyed an incredible run-up this year. Proponents say we're just in the early stages of a long-boom driven by China and other newly industrializing countries that will mean high demand for copper and other basic commodities for years to come. Bears, who've watched commodities pull back sharply in recent weeks, argue that we've finally peaked and more pain is on the way. What no one disagrees about is the power of the nearly vertical rally in base metals - copper, zinc, nickel, aluminum, lead - and in the shares of the companies that extract them from the ground. Since the beginning of this year, copper has gone from $4,400 per ton to $8,075. Zinc has done even better, rising from $1,910 to $3,537, according to Barclays metals analyst Ingrid Sternby. "Fundamentals and speculative factors have gone hand in hand," says Sternby. "If the fundamentals weren't supportive, we wouldn't have seen higher prices." Maybe so. In any case, I'm not going to make a call on commodities - if I were that good, I'd be sitting on my own island in the Caribbean and not writing this column. But what I will say is that individual investors should proceed with extreme caution, both in terms of investing in commodities themselves and in buying newly popular metals plays like Phelps Dodge (Research), Freeport-McMoran (Research), Southern Copper (Research), BHP Billiton (Research), and Rio Tinto (Research). This doesn't mean they'll go down - heck, they might keep heading straight up - but it won't be a smooth ride in either direction. Copper looks especially vulnerable. Along with wiring and other industrial uses in places like China, copper also goes into new home construction in the United States. If the U.S. homebuilding market slows (not unlikely in view of higher rates) or economic growth drops from its currently blistering 5.3 percent rate, copper demand could certainly ease. That would hit shares of Phelps Dodge hard. A smarter, more diversified play for cautious investors is Australia's BHP Billiton. As London-based metals hedge fund manager Keiron Mathias notes, BHP is strong in iron ore and coal as well as hot base metals like zinc and copper, while shares of Phelps Dodge are much more correlated to volatile copper prices. The last time around we had a fad like this, individual investors who got burned on Internet stocks claimed they were misled by the Henry Blodgets and Mary Meekers of the world. And many strategists and analysts remain bullish on metals now. They argue that even if prices decline a bit more, high-quality companies like Phelps Dodge will continue to make big money. That's true - but that doesn't mean even higher metals prices aren't already priced into the stocks. If you don't believe me, check out the drop in oil-related shares recently. Energy companies are still on track for multi-billion dollar profits this quarter, gasoline is still at $3 a gallon, but the modest pullback in oil prices has pulled shares of even the best-managed companies like Exxon Mobil and BP lower. So if copper comes a cropper, don't say you weren't warned. _____________________________
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