Mover Mike

When you buy stock in a natural resource company, you expect to reap capital gains if the price of oil, or silver or gold or copper go up. The reason is leverage. Your costs remain relatively fixed but your revenue soars. Or that's how it should be, only it's not with today's announcement from Phelps Dodge (PD), and If I were a shareholder, I would be livid.

According to the WSJ Online (by subscription only),

PD's second-quarter net income fell 31% despite high commodity (copper) prices, due to a huge charge tied to hedges the company put in place to protect against volatility of metals prices.

Seems PD sold options on copper at an average $.95 and copper double and doubled again. They had to buy them back! It cost them

$514.6 million...for mark-to-market adjustments on copper price collars and put options that covered about 25% of its production. Similar hedges cover about 20% of Phelps Dodge's 2007 production, and the company declined to say whether it would try to unwind those.

So PD investors be prepared for some more disappointing earnings.

Now PD is not alone. Barrick Gold Corp. (ABX) has done much the same thing in Gold with options averaging prices of $300 per ounce. Gold has doubled and is likely to double again and again and again. Meantime, ABX is only down $3 Billion. But, hey, it's only shareholders money and the government will probably bail ABX out. The lesson for shareholders: do not buy shares in companies that hedge their production.

Derivatives Phelps Dodge PD Barrick Gold Corp. ABX Mover Mike