Evidence of a slowing US economy is more palpable than ever. Copper prices, on the other hand, hit above $4 a pound this week, surpassing the all-time high reached in 2006.

The clear upshot: There are other forces driving copper prices despite weak US demand from the battered housing sector. And as they become increasingly irresistible, they’ll send the price of copper and copper stocks even higher in coming years.

As we’ve pointed out, driving force No. 1 is growing Asian demand, particularly from China. Most expect the Chinese economy to grow somewhat slower in 2008 than last year’s 11.4 percent, which was the fastest rate in 13 years. But with an estimated 200 million people moving to China’s cities over the next two decades, the build out of the country’s infrastructure must go on. And copper is absolutely essential to the effort.

Last year, China contributed 23 percent of global demand for copper. In the first two months of 2008, the country increased its imports of copper concentrate by 32 percent from 2007 levels. And the country’s top supplier expects imports for the entire year to rise 20 percent, in part to feed a growing fleet of smelters.

Reflecting China’s insatiable appetite for Big Red, the government has suspended tariffs on imported copper this year, a move that both reduces the cost to users and encourages more imports. And, as is the case with energy and a score of other vital resources, it’s also on the prowl for takeovers to lock up reserves abroad.

Earlier this year, Aluminum Corp of China (Chalco) and Alcoa combined to pay $14 billion for a 9 percent stake in VRI Portfolio holding Rio Tinto (NYSE: RTP). This month, the rumor mill is rife with speculation China will make a move for a piece of Rio’s chief rival and suitor, BHP Billiton (NYSE: BHP).

Australia-based Rio and BHP have plenty of resources China needs, from copper and coal to aluminum and iron ore. Rio management continues to rebuff BHP’s takeover offers. But if a combination were to be achieved, it would dominate production of a wealth of vital resources right on China’s doorstep with the market power to set prices.

Chalco and Alcoa were willing to pony up a hefty premium for Rio to what BHP was offering. A sizeable stake in BHP is likely to command an equally high price. One reason: Secure and reliable supplies of the red metal–as well as those of other vital resources–are increasingly scarce. And BHP and Rio Tinto control a good bit of what’s left.

For example, Chile has been the world’s largest producer (35 percent) of copper for many years, mostly from government-owned Codelco. This year, however, reduced natural gas imports and lower water flows to hydro plants have triggered electricity shortages throughout the country. That’s raised the possibility that power could be rationed for Codelco and other resource operations, hitting copper production and tightening supplies.

This is, in essence, what’s happened to global platinum supplies this year. A shortage of coal triggered electricity blackouts in South Africa that radically reduced output by forcing the country’s mines to shut for five days in January. The result: a sharp drop in global inventories and a corresponding spike in platinum to well above $2,000 an ounce.

Source: Bloomberg

There are currently several major mining projects going on around the world to boost copper output significantly over the next five years. VRI Portfolio holdings Freeport McMoRan Copper & Gold (NYSE: FCX) and Xstrata (UK: XTA, OTC: XSRAF) both have aggressive expansion in the works. It’s also likely that at least some of copper’s run of 30 percent-plus this year is due purely to speculation, which can easily unwind.

As we’ve noted previously, our forecast for copper has been for a choppy first half in 2008, as the global economy works to find a bottom. Our expectation is that a robust second half will follow as the US cycles out.

We’ve been willing to stick with copper stocks for two reasons, despite a great deal of volatility in their prices. First, they’re already pricing in a rather dour outlook for the red metal this year. And second, despite the apparent collapse of Companhia Vale do Rio Doce’s (NYSE: RIO, CVRD) attempted Xstrata takeover, copper stocks remain prime targets for high-premium takeovers. Freeport shares, for example, have already been lifted on talk of a possible bid from CVRD.

Supply challenges, however, can literally trigger a windfall at any time. We’re not yet willing to say that a slowing global economy won’t curb copper again this year, before a second-half 2008 rally begins in earnest. But we’re more convinced than ever that the red metal is a sound investment in April 2008.

That’s a great reason to pick up shares of our more direct copper plays Freeport and Xstrata. And it’s in part why we’re very bullish on diversified miners Anglo American (NSDQ: AAUK), Rio Tinto and CVRD. Also note that, although it’s not officially in the VRI Portfolio, BHP is a buy in our How They Rate coverage. For a list of all the stocks we track closely, see the How They Rate Table in the Portfolio section, which can be accessed on the left-hand side of the VRI Web site.

BHP and Xstrata are also attractive for their coal exposure. Production problems, chiefly in Australia, have sharply limited global supplies this year. That’s had a profound impact on the steel industry, which is a major consumer of the black mineral, particularly the metallurgical (met) or hard coking variety.

Japan and South Korea are huge steel manufacturing countries. Japan produces some 119 million metric tons of steel a year, and South Korea produces around 50 million metric tons. Together they account for about 12 percent of total global steel production and need to import literally mountains of met coal to manufacture it.

This is the time of the year when producers and major consumers of met coal sit down to hammer out agreements on material prices for the year. The stakes are particularly high this year, as euphoria about high demand and low supply has driven spot market prices ever-higher.

According to the first non-official information, BHP is understood to have agreed to sell coking coal to steel maker ArcelorMittal (NYSE: MT) for USD305 per ton. VRI Portfolio holding Posco (NYSE: PKX) is expected to settle for USD300 per ton. The latter settlement would be the mid-point between the expected final price of Peak Downs coal (premium hard coking coal) at USD305 per ton and Gregory coking coal at USD290 per ton.

The reason for these high prices is what we’ve been covering all along. Namely, an indisputable supply-side shock has been taking place across the board. See VRI, 7 February 2008, The Great Game.

When it comes to coal, the main problem was the flooding of Queensland’s Bowen Basin in Australia at the in the beginning of 2008. Because this is the world’s largest source of high-quality export coal, it was certain that prices would spike in response. High prices coupled with the chronic infrastructure problems–which limit the country’s ability to handle the extremely strong Asian steel mill demand–mix one explosive cocktail.

That’s good news for coal producers. Unfortunately for the steel makers, these increases are coming on top of the recently negotiated 70 percent increase in the iron ore prices. As a result, they’ll need to raise steel prices even more in order to offset these higher costs. Korea-based steel producer Posco (NYSE: PKX) did raise its carbon steel price by an average of 10 to 11 percent in the first quarter, but the company will likely need to aim for an additional 20 percent to cover all cost increases.

Given that global steel demand remains strong, particularly in Asia, we expect Posco to be able to raise prices to cover increases. The stock has been hit dramatically in the last five months. But the current weakness offers a good opportunity to own one of the best steel companies in the world.

Our long-term bullish view on steel is based primarily on the infrastructure growth in the developing economies, as well as the energy construction around the world. On the latter, strong oil prices will continue to support infrastructure spending for pipelines, windmills, oil rigs and other related steel-intensive uses. Shipbuilding and growth in auto production will also be big drivers.

Should the economic slowdown intensify, it will affect prices negatively. As a result, you should be ready to endure some short-term pain for long-run gain. The upcoming Chinese GDP announcement will be a good test, although the bar will be set lower than usual due to the extremely poor weather that paralyzed economic activity in China in early 2008. Buy Posco.

In contrast to Posco’s relative weakness, Mechel (NYSE: MTL), Russia’s second-largest producer of long steel products, has outperformed.

The company’s ace in the hole is a mining business that focuses on raw materials used in making steel, primarily coking coal, iron ore, nickel and steam coal. The company’s steel business is 100 percent self-sufficient in coking coal, 80 percent in iron ore and 50 percent in electricity. We’ve always viewed this as one of the biggest advantages in a world in which raw material prices have been constantly increasing.

Two days ago, Mechel announced that it acquired Romania’s steel producer Ductil Steel for USD221.0 million. The acquisition will help Mechel strengthen its market position in the Romanian market, where it already owns two steel mills with crude steel capacity totaling 0.9 million tons. Buy Mechel.

On the other side of the deal is Xstrata, which continues to benefit from strong coal prices. The company is the world’s largest exporter of thermal coal and a significant producer of hard coking coal and semi-soft coal. That’s in addition to being the world’s fifth largest diversified metals and mining company, including the fourth largest global copper producer and the fourth largest global nickel producer.

Although the company wasn’t acquired by CVRD, we still favor it. It’s well positioned to benefit from the ongoing strength in commodities, and we expect action in the mergers and acquisitions (M&A) game as well. Buy Xstrata.

Source: Xstrata Company Data