The many industrial uses of copper give copper stocks an advantage over gold and other precious metal stocks.

Traditionally, investors have bought copper stocks as a way to profit from general economic growth. Copper has a wide range of industrial uses (unlike gold and silver, which are thought of more as hedges against inflation). Copper is heavily used in the power-transmission and construction industries, in cables, wires and plumbing.

Gold stocks have appeal, but we don’t see gold as essential to a sound portfolio. You should have some Resources & Commodities exposure—10% to 20% is a good proportion for most investors. But rather than focusing solely on precious metals, we think you are better off getting some of that exposure through oils and base-metal producers as well, including copper producers.

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Copper prices do tend to rise with inflation. But copper has the added advantage that its price also rises with industrial demand.

Moreover, stocks of firms that produce oil and base metals, including copper, generally have higher dividend yields than gold stocks. As well, they’re usually much cheaper than gold stocks in relation to their earnings and cash flow. That means they potentially have less room to fall if markets fall. That’s just another way of saying they can be considered somewhat less risky than gold.

Tight supply, emerging market demand could send copper even higher

Copper should benefit not just from rising demand, but also from tightening supply. In the short term, labour problems and technical delays will continue to slow global copper production.

Over the longer term, ore grades are falling at many major mines around the world as producers use up the easy-to-mine ore zones in their copper deposits. Environmental issues are also making it harder for companies to acquire permits for new mines.

High prices will, of course, in the long run boost exploration efforts to discover new mines. Meanwhile, rising copper prices will lead mining companies to re-evaluate copper deposits they had previously dismissed as too low-grade to mine when prices were lower. Within existing mines, parts of a deposit that formerly seemed like waste rock can become profitable at higher prices.

Moreover, the higher copper’s price goes, the more incentive manufacturers have to re-design their products to use less copper wherever possible, or eliminate copper altogether. In addition, as recycling efforts get more widespread and efficient, they will bring more recycled copper to market.

Still, the combination of rising demand and uncertain supply will likely push copper prices higher over the next few years. The best way to profit from that is to invest directly or indirectly in copper stocks.

To sum up, we like copper’s long-term prospects. But as always, stay out of promotional penny mines that are merely drilling for copper. Also stay out of investment vehicles (like options or futures) that will only make money for you if copper keeps going up in the short term.

However, most investors’ portfolio should include 10% to 20% exposure to the Resources and Commodities sector of the economy, and that includes copper stocks.

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Nine tips for picking a profitable mining stock

1. Location: We generally stay away from mining companies that operate in insecure and politically unstable regions like the Congo, Venezuela and Colombia. We also avoid those in countries with little respect for property rights and the rule of law, such as Russia or Mongolia. Mining is particularly vulnerable to political instability. You can’t move the mine to another country, and local citizens may sometimes get the impression that a foreign mining company is robbing them of their birthright, even though the foreign company’s capital and expertise would appear to be the best way to get any value out of the ground.
2. Environment: We look at environmental constraints where juniors are looking for minerals. In Europe and certain parts of the U.S, they need a particularly rich find to justify the costs of overcoming environmentalists’ objections.
3. Geology: When we recommend junior mining stocks that only explore for minerals, we prefer those that operate in an area with geology that is similar to that of nearby producing mines.
4. Financed: We look for well-financed junior mines with no immediate need to sell shares at low prices. That’s because doing so would dilute existing investors’ interests. The best junior mining firms have a major partner who has agreed to pay for drilling, or other exploration or development, in exchange for an interest in the property.
5. Low debt: We like mining stocks with strong balance sheets and low debt. Debt can be a big problem for a junior miner with no cash flow.
6. Profitable: When we recommend mining stocks, we want to see positive cash flow, preferably even when commodity prices are low.
7. Really profitable: Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient for, or at least contributes to, the cost of developing a second mine.
8. Well-managed: We want to see mining firms with experienced management with a proven ability to develop and finance similar projects by working with other junior mining companies.
9. Expensive: We avoid mining stocks that trade at unsustainably high prices because of broker or media hype or investor excitement about the underlying commodity (such as gold). Instead, we focus on reasonably priced mining stocks with favourable geology.

Have you invested in copper stock picks in the past? Have they been profitable for you? Share your experience with us in the comments.