Just one week ago the price for copper hit US$3.04 per lb and seemed to be heading into a tailspin. But suddenly the price stabilized, and only eight days later it reached a high of US$3.32 before closing at US$3.31 per lb. What ever could be going on?
While the bounce back ensured that the price remained within its recent trading pattern band of the last four months between $3.38 per lb and US$3.04 per lb, the metal’s recent movements are counterintuitive to many watchers trying to determine the cause of the price action.
One point of perplexity is tied to its movement in late May. Late in the second quarter LME inventories showed a large spike in the number of orders to withdraw the metal from warehouses. Most analysts believed that such a great uptick in orders was a sign of surging demand and braced themselves for stronger prices going forward.
Instead, however, the metal sold off through June, giving back as much as 9% at one point as it briefly touched US$2.99 per lb.
When trying to make sense of such counterintuitive events, it is important to understand that the waters have been muddied in the copper market by a spate of warehouse acquisitions by the big metal traders. Spurred on by, for one, Goldman Sachs (NYSE: GS) much discussed acquisition of Metro and its large metal warehouses, the biggest players in the metal game wanted a piece of the action. So Glencore Xstrata (LON: GLEN) bought Pacorini Group, Trafigura’s bought North European Marine Services (NEMS); the Noble Group bought World Wide Warehouse Solutions (WWS); and Louis Dreyfus Commodities bought GKE.
What made such acquisitions desirable was that in a low interest rate environment the big players realized there was much to be gained by storing the metal and earning rental or storage fees for a commodity that could be sold in the futures market at a higher price.
That surge in acquisition activity greatly reduced the number of independent LME warehousing companies to just 35% of the industry by some estimates.
So what does it mean for copper?
It means investors that look solely at supply and demand fundamentals in the industrial market could be left befuddled going forward. There is now a new factor that needs to be taken into consideration when trying to assess the metals price. That is its use as a financial instrument.
The problem is, that even once this realization is made, getting a handle on just what players like Glencore, Trafigura or Goldman Sachs and Morgan Stanley are up to is difficult. So much so that one of the main arguments being brought before the Federal Reserve as it examines whether or not to allow institutions like Goldman and Morgan Stanley (NYSE: MS) to continue their foray into the commodity space, is that there isn’t a regulator in the world that could unwind and comprehend all the machinations of the firms commodity investments in conjunction with their regular financing business.
One thing that is more clear, as discussed in a recent article on aluminum prices, should the copper future curve tip into backwardation, the motivation to buy the metal on the spot market, store it, earn the storage fee, and sell it in the future market, would evaporate.
Currently the future curve is in contango, but it would be wise for investors to monitor the curves movements in the coming months.
And while future curves are an important factor in today’s metal markets, the influence of industrial fundamentals persist, as well.
On that front China remains the dominant player in the copper market, accounting for roughly 40% of the metal’s demand and there are signs that the Asian Tiger is gearing up for more consumption.
The country’s State Council recently announced a small stimulus package after weaker than expected growth numbers persisted through the first half of the year. The package includes the removal of taxes on small business, cuts to administrative costs for exporting companies, and the encouragement of private sector railway investment through bonds.
The country is at the same time pushing for the construction of more affordable housing, which is also good for copper as it is used in house wiring.
Those moves seem to be already working, as the latest numbers out of the country show that industrial output rose 9.7% in July from a year earlier, and that came after 8.9% growth in June. The country also said its July copper imports rose 12% from a year earlier to 410,680 tonnes, which is the highest level since May of last year.
Patricia Mohr, an economist with Scotiabank wrote in a recent report that copper demand had already been robust this year, even before the latest numbers, and argues that the decline in the copper price over the first half of the year had more to do with expected new mine development than softening demand.
Turning to back to the future market for clues to the metals movements, it can be helpful to look at what the smart money is doing in terms of long and short positions in the metal.
The best place to get a sense of this is the Commodity Futures Trading Commission (CFTC) report. By focusing on the Managed Money category, as Managed Money is considered the “smart money”, we see that while short position contracts are nearly double that of long — roughly 41,414 short contracts compared to 26,753 long contracts, with each contract representing 25,000 lb of copper — the short positions have been scaled back recently by 11,162 contracts while 1,100 new long contracts were added. So the trend in the futures market is bullish for copper.
Lastly, let’s turn to some technical analysis to round out our picture of the current state of the red metal.
The first thing that jumps out is that the Bollinger bands are expanding after a recent move in price to the upside. Bollinger bands expanding after a period of tightening, as they have been for copper over the last month, is a bullish indicator, as it could indicate a break to new short term highs.
Also the 21-day moving average crossed over the 50-day moving average, another indicator that the metal is generating some positive momentum.
Finally, both stochastic and RSI indicators have just entered the overbought zone. That is not necessarily a bad sign, as quite often the indicators will remain in that zone for a given period time as the metal continues to gather steam.
So while predicting metal prices is a fool’s game, there are some positive signs developing in the copper market. The wild card of course is the games that the big banks and big trading companies will be playing going forward. If they decide to unwind positions, either due to regulator pressure, or simply because the carry trade on the metal no longer works, then investors could see a steep movement to the downside.
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