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The
spot price of copper jumped to $4.40 on December 31, exceeding previous highs
set daily over the past week. Today we discuss copper’s meteoric price
rise during the past five months, dissect current supply and demand
fundamentals, and opine on the direction of the market in the short term.
Just
under a year ago, I predicted a short term correction in the price of copper
based on analysis of supply and demand (Mercenary Musing,
January 18, 2010;
Mercenary Musings
Radio, January 28, 2010). My prediction quickly came to pass but was of
shorter duration than I expected.
My
radio partner Rob Graham and I re-visited the copper market twice in 2010. In
our second interview (Mercenary Musings
Radio, May 6, 2010),
I was bearish on the short term prospects for copper. The price went on a
downtrend that lasted until financial markets righted themselves in early
July after a short summer doldrums. By late July, I became bullish on the red
metal (Mercenary Musings
Radio, July 27, 2010). The price was going up, I felt it would continue, and
since then the robust copper market has seldom paused for a respite:
 
The
record copper price is being driven by speculators, hedge fund buying, and
Chinese stockpiling and hoarding. Although copper is up 55% since its low of
$2.77 in late June, the supply and demand fundamentals simply do not support
all time record prices.
I
currently see several reasons why the copper market is overbought and a
correction is in order:
- Projected
world supply deficits for 2011 have been promulgated as extremely
bullish for the copper price. However, these predictions are only 8-11
days worth of current yearly consumption. This is insignificant. Whether
there’s an actual surplus or deficit in 2011 is primarily
dependent on the health of the world’s economy and supply factors.
One of the estimates factors in an annual supply disruption at 4% of
projected world demand. If that fudge factor is removed, the projected
11 day deficit turns into a 3 day surplus. Projected estimates of 2011
supply or deficit are certainly with the margins of error of the
predictions.
- Worldwide
copper warehouse inventories are trending up. The current LME, Comex,
and Shanghai warehouse stockpiles, although down 30% from highs in
March, are still over two to three times the average for five years
preceding 2008’s global financial crisis. Inventories are now
equal to 10 days of global consumption; this is down from 12 days in
March, but is still high compared to the average of 3-4 day stockpiles
from 2002 to 2007. LME
warehouse inventories have gone up for 12 consecutive days.
·
The Baltic Dry
Index global freight rates are at a four month low suggesting that underlying
real commodities demand is weakening.
·
Copper is in
contango and no longer in backwardation as it was from early November until
early December. This indicates a lessening of current demand.
·
This is the
season of low consumption: Northern Hemisphere winter and slow construction
season; Western World holidays; and Chinese New Year for 15 days in early
February.
·
The Chinese,
with an interest rate increase on Christmas Day, are attempting to contain
inflation. Food inflation is a major concern in developing Asian countries,
particularly China, India, and Indonesia where it is the poor’s major
expense, constituting nearly 50% of income. Significant interest rate
increases will cause commodities prices to drop with hedge fund divesture
into attractive income-producing sectors.
Now
let’s look at the factors that argue for a short term bullish view on
the copper price:
·
Hard
commodities, with exception of gold and to a lesser extent hybrid metals
(platinum, palladium, and silver), are bulk industrial materials with prices
largely controlled by supply and fundamentals. Growth of consumption in the
BIIC (Brazil, India, Indonesia, and China) countries is continuing for all
base metals but especially copper as the developing world demands
electricity. “Dr. Copper, the only metal with a PhD in Economics”
is reflecting strong consumption from worldwide emerging markets.
·
Countries in
the world are depreciating their fiat currencies because of overwhelming debt
obligations, huge budget deficits, and overall slow global economic growth.
The across-the-board currency devaluation is especially important for the United
States dollar since all commodities are priced in the world’s reserve
currency. Commodity prices naturally will appreciate as the dollar
depreciates.
·
Speculative
money has been pouring into the copper sector and most other hard and soft commodities
for the past six months. The main driver is low interest rates and a weak
dollar. High risk money will always flow into the sector where short term
return is perceived as highest.
·
At the present
time, commodities are the preferred sector for speculators and hedge funds.
This is a similar situation to the first half of 2008, which was the last
time we saw across the board record commodities prices.
·
Copper is in
record territory and the price could continue to go up with no resistance
points to the upside.
There’s a wild card in
the hand we’ve been dealt to determine the short term direction of the
copper market. Two major financial institutions, Blackrock Capital and
JP Morgan, have made application to the New York Stock Exchange to launch
physical copper ETFs. They have yet-to-be approved for trading. Although they
use different business models, both could control significant positions in
the inventory markets. The former is of concern for its ability to honor
redemptions in physical metal and has an option to pay in cash. The later
could cause short term market disruptions if dominant long positions lead to
forced reductions by the LME. In addition, ETF Securities of London is
establishing base metal funds for copper, nickel, tin, and aluminum.
Some pundits are calling for
as much as a 10-20% increase in copper prices if and when physical copper
ETFs are trading. They certainly will add near term volatility, tighten
supply markets, and cause price increases. On the other hand, given
today’s record high price of copper, perhaps the market has already
factored in the debut of physical metal ETFs.
If copper prices continue to
go higher, we will see a negative impact on major industrial activity with
increasing capital and operating costs. This scenario happened previously in
early to mid-2008 before commodity prices collapsed in the later part of the
year.
At this juncture, it does
not appear to me that basic supply and demand fundamentals are strong for the
copper market in the short term. There is evidence to indicate that the
market is overbought by speculators and hoarders. That said, there are other
factors, especially the new copper ETFs that could drive prices substantially
higher.
Although I subscribe to
Austrian economic theory and disdain Keynes, I will not forget what he said:
“The market can remain irrational longer than you can remain
solvent.” Irrational exuberance for copper could continue at increasing
prices.
I also remember the old
adage: “The cure for high prices is high prices”. Markets always
will revert to the supply and demand fundamentals of capitalism.
I
get really nervous when the all the experts, pundits, mavens, gurus, savants,
and wizards are jumping on board the same bandwagon, whether bull or bear.
The current consensus amongst analysts is for a higher copper price.
This is a frothy, risky,
volatile market right now. At times like these, I prefer to sit back and
wait. I see very high risk in the copper market at present and will watch
from the sidelines while the game is played out and winners and losers are
determined.
Will the price of copper go
up or down in the short term? In the words of former St. Louis Cardinals
pitcher and wing nut Joaquin Andujar: “There is one word that says it
all: You never know.”
I am not buying or selling
copper or copper-gold stocks at present. That said, it’s always good to
take profits when a market reaches all time highs. I will leave that personal
decision up to you as a diligent lay investor.
Despite
my queasiness about the current state of affairs, I remain a long term
secular bull for copper and other industrial commodities. Simply put, we are
not finding and developing enough big copper deposits to satisfy the projected
world demand for the next 20 years. I will address this issue at some later
date.
Ciao
for now,
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