Copper has become the SPX’s Siamese twin! Since stocks’ despair lows in
March, the technical chart patterns of copper and the SPX are almost
interchangeable. If I had
mislabeled the blue copper line and red SPX line above, not many traders
would catch the error with a casual glance. For the most part, copper has been
rallying when the SPX is strong and retreating when the SPX is weak.
This relationship extends well beyond the visual to the
statistical. Since the SPX
bottomed on March 9th, the daily copper close has had a correlation r-square
of 94.1% with the SPX. This means
94% of copper’s daily price action is statistically explainable by the
SPX’s own! This is all the
more remarkable considering I’m using copper’s global benchmark
prices from the London Metal Exchange here.
Why would worldwide copper prices follow American stock markets with
such precision? One reason
only. The mighty advance in US
equities has set the tone for universal sentiment. Traders nearly everywhere, trading
nearly everything, are seeing the continuing SPX rally and assuming it means
underlying economic conditions are improving rapidly. So they are bidding up nearly
everything else with it.
Provocatively copper carved its own panic low near $1.28 in late
December 2008. But as you can see
in this chart, it struggled near this low for months until the SPX finally
started rallying in March. With
stocks’ despair finally morphing into hope, copper traders finally felt
comfortable bidding up copper prices again. This turning point had some
fundamental underpinnings too, as copper stockpiles on the LME topped in late
February 2009 just 8 trading days before the SPX bottomed.
Since the recovering stock markets first recast global economic
expectations in a hopeful light again, copper has never looked back. It has powered higher in a very-tight
uptrend that mirrored the SPX’s own almost perfectly. While such a steep uptrend was
certainly justified in the first half of 2009 emerging out of those
deeply-oversold lows, its continuing in the second half unchecked raises all
kinds of concerns.
Between March and September, copper’s surge higher was very fast
but properly punctuated by periodic pullbacks to rebalance sentiment. In late April, copper plunged 12.2% in
8 trading days before resuming its nascent uptrend. In June and July during the
SPX’s own last meaningful pullback, copper slid 8.5%. And finally in September, a third
pullback dragged it down 9.8%.
Such two-steps-forward-one-step-back behavior is normal and expected
in even the strongest bull-market advances. The periodic pullbacks are a critical
mechanism that keeps popular greed in check. If greed gets out of hand too soon, it
will burn itself out and prematurely kill the upleg. All traders interested in buying soon
will be sucked in, leaving no new near-term buyers. At that point the upleg fails.
But since October, we’ve seen no meaningful copper pullbacks at
all. Copper’s first
pullback happened about 1.5 months into this surge, its second another 1.5
months after the first one ended, and the third almost 2 months after the
second ended. But since early
October, we’ve seen a very long 3+ month span where copper has
relentlessly powered higher. This
is a long time for greed to flourish unrestrained.
Such unbalanced behavior has led to extremely overbought
conditions. In late October
copper stretched 1.374x above its baseline 200-day moving average. By early December and again this week
it was back up to 1.331x. This is
extraordinarily overextended technically, a very dangerous place for copper
prices to be. These levels were
rarely rivaled (or sustained) in copper’s strong bull years prior to
the stock panic.
Between Q2 2004 and Q3’05, copper advanced relentlessly yet
rarely exceeded 1.17x its 200dma.
After a short-lived parabolic spike higher in Q1 and Q2 2006, copper
again stayed under this 1.17x metric at the tops of its strongest uplegs (and
there were quite a few) between Q4’06 to Q3’08. If you look at a Relative Copper chart (updated weekly on our website for our subscribers), it is very rare for copper to exceed 1.20x its
200dma. Today’s sustained 1.33x+ levels are just
absurdly overbought.
The driver of these extremes, as this chart reveals, has been the US
stock markets’ seemingly unstoppable advance. Copper tends to rally on days the SPX
rises, but at a faster pace. And
it tends to sell off on days the SPX retreats. But since the stock markets
haven’t seen anything close to a meaningful pullback since June and
July, the positive sentiment they are casting into the copper realm has been
uninterrupted.
Given the stock markets’ state, this is very troubling. Like copper, the SPX has long been
very overbought as I’ve been chronicling in our subscription newsletters.
Complacency in the stock markets is extraordinarily high, almost
everyone is bullish and nearly no one expects an imminent or sharp
retreat. Such conditions,
technically overextended without a fear in the world, are the best breeding
grounds for violent corrections.
The SPX has been overdue for a pullback for several months now.
And just as copper has eagerly followed the SPX higher like a lost
puppy, it is sure to be hit hard when this SPX levitation act suddenly gives
way. Copper has rallied because
rising stock markets have convinced copper traders that everything is well
and the global economy is likely to grow faster than expected. But falling stock markets breed
economic fears much more efficiently than rising ones create economic
hopes. When the SPX’s
enchantment on the economic outlook is dispelled, copper will fall fast.
While this metal’s greed-laden sentiment and
incredibly-overbought technicals are more than enough to nearly guarantee an
imminent sharp correction, the fundamental state of copper seals the
deal. The base metals traded on
the London Metal Exchange enjoy a unique real-time window into their
fundamental state that few other commodities share. Every trading day, the LME publishes
total copper stockpile levels across its global network of storage warehouses.
While most copper moves directly from the miners to the industries
that consume it, the LME warehouses act as a buffer on the margins. If miners produce more copper than they
are under contract to provide, they can deliver it to LME warehouses. If consumers need more copper than
they have contracted to buy from miners, they can take delivery from LME
warehouses. Thus the trends in
these LME stockpiles offer outstanding insights into copper supply and demand.
Normally copper-futures traders drive copper prices in opposition to whatever trend
happens to be unfolding in LME stockpiles, which makes perfect sense. When LME stockpiles are rising, it
implies that copper supply growth is at least temporarily exceeding demand
growth. Traders generally sell
copper in response to these near-term-bearish surpluses. And when LME stockpiles are falling,
demand growth is presumably exceeding supply growth. Traders buy copper when these bullish
deficits arise.
Amazingly, the long shadow of the SPX’s universal influence on
sentiment has temporarily torpedoed this strong historical relationship
between LME copper stockpiles and this metal’s prices. Copper traders are so enthralled by the
SPX’s seemingly impregnable advance that they have been willing to
totally ignore utterly massive
builds in copper stockpiles! This is
unprecedented.
Prior to late 2008’s stock panic, copper prices lazily meandered
higher in opposition to LME stockpile levels. When LME stockpiles were drawn down to
the bottom of their pre-panic range, around 100k metric tons, copper prices
rallied to the high end of their own range. Conversely when LME stockpiles were
built up near the top of their range, 200k tonnes, copper slumped. This is a perfectly logical
fundamental response.
LME stockpile levels normally influence copper sentiment in a variety
of ways. They act as a critical
buffer in the case of any meaningful supply disruption, like some big copper
mine going offline due to a labor strike. The lower the LME stockpiles are, the
smaller the buffer in the global copper trade to absorb any unforeseen
shocks. So lower stockpiles drive
copper higher as it reflects a larger uncertainty premium. Higher stockpiles give the markets
breathing room in case of disruption, shrinking the premium.
In Q3’08 just prior to the stock panic, LME stockpiles were just
under 210k tonnes at the top of their range. This led to copper being down near its
own trading range’s support, of course. But when the panic hit, both copper
traders and consumers were terrified.
Yet the miners kept on mining to pay the bills. The traders sold copper futures
aggressively, desperately dumping everything to get their capital out of
harm’s way and raise cash.
So the copper price plummeted with everything else.
Meanwhile the copper consumers were reacting on two fronts. Stock-panic sentiment was kindling
fears of a new Great Depression, and industrial copper users didn’t
want to overproduce their goods if we were facing such a bleak new economic
reality. So they scaled back
purchases as much as their contracts allowed. And for the copper they did need,
prices were plummeting so fast that it made no sense to lock them in too
soon. With mined copper supply
pretty stable while demand flagged, LME stockpiles soared.
By late February 2009 they peaked at just over 548k tonnes, a
tremendously high level by previous years’ standards in their
100k-to-200k trading range. But
once it finally became clear that the despair was overdone and the
neo-depression fears were silly, copper demand picked up relative to supply
and LME stockpiles started dropping rapidly. By mid-July they had plummeted 53.2%
to just under 257k tonnes.
Over this span, copper prices soared 49.6%. This February-to-July copper rally was
totally fundamentally-justified.
With LME stockpiles quickly shrinking, apparently reapproaching their
pre-panic trading range, copper prices needed to rise to reflect this
persistent structural deficit.
Copper traders dutifully bid it higher as the LME buffer to absorb any
copper supply shocks shrunk rapidly.
This worked until mid-July, when a disconnect emerged. It was no big deal at first, but it
has since grown into one of the weirdest copper anomalies I’ve ever
seen. A couple days before the
LME stockpiles bottomed, the SPX’s last meaningful pullback ended. Economic sentiment swung from pretty
negative during that 7.1% SPX retreat to pretty positive once the SPX started
surging higher again in the second half of July. The spillover effect of these positive
perceptions infected copper traders as well.
So they started buying futures again, but ignored the troubling
fundamental undercurrent of rising LME stockpiles. Early on, they could ignore the build
and rationalize that stockpiles would soon turn south again. But it never happened. Like an ocean-going tanker slipping
off course by a few degrees, at first this disconnect was trivial. But as the weeks passed, it gradually
grew into a major fundamental disconnect.
Between mid-July and this week, LME copper stockpiles soared by
97.5%! Meanwhile, copper prices
also rose by 51.4% over this very span, driven by the warm-and-fuzzy economic
expectations the levitating SPX is casting. One year ago, if you had told copper
traders that they would drive copper 50% higher over a period of time where
the LME stockpiles doubled, they
would have laughed you out of the room.
Such a thing was inconceivably absurd to even consider.
Yet here we are. Exceeding
507k tonnes this week, copper stockpiles are once again rapidly approaching their panic highs near
548k tonnes! Yet in the couple
months surrounding those highs, the copper price averaged $1.58. Today it is over twice as high. And back in the pre-panic days when
copper last traded around today’s $3.40ish levels, LME stockpiles were
only about 40% of today’s lofty levels. This is just a stunning fundamental
disconnect that cannot persist.
At some point here, probably soon, copper traders are going to snap
out of their SPX-spawned enchantment and start thinking about stockpile
fundamentals again. That day will
probably come when the SPX inevitably corrects, which will rapidly turn the
economic perceptions pessimistic again.
The copper traders’ shock when they sit back and realize how
foundationless the rally since July was will be serious. I suspect there will be a rush for the
exits and copper will plunge rapidly.
Just as the greedy sentiment in copper alone, or its terribly
overextended technicals alone, argue for an imminent correction, so does its
crazy fundamental disconnect over the past 6 months. But when you add these sentimental,
technical, and fundamental pictures together, it is nearly impossible to
imagine copper not correcting sharply.
So we are probably on the verge of a perfect-storm copper correction,
and the trigger that ignites it will likely be the arrival of the overdue SPX
correction.
It’s funny, as many traders fear corrections. The falling prices exert heavy
psychological pressure on them, making them feel unsettled and
frightened. But as investors and
speculators our mission is to buy low and sell high, and corrections create
the opportunities to do both. The
peaks before sharp corrections emerge are the best opportunities to sell high
within an ongoing bull while the subsequent troughs after corrections mature
are the greatest opportunities to buy low.
At Zeal, we are capitalizing on both. We just added a new options trade in Zeal Speculator this week that will surge if copper corrects
sharply. And late in December we
finished a 3-month deep-research project looking into the universe of
publicly-traded junior base-metals
stocks. We wrote and published a
fascinating new 24-page report profiling our dozen favorite base-metals
juniors. These elite companies
have outstanding projects and great fundamental potential to multiply in
price many times over.
And a copper correction, which will drag down the rest of the base
metals in a heartbeat, is the perfect event to create an outstanding
base-metals-stock buying opportunity.
When these metals fall, probably in concert with the general stock markets,
base-metals stocks will be crushed. Those prudent investors and speculators
anticipating this event will be ready to buy aggressively near the lows. Now is the time to start researching
to figure out which companies you want to purchase at bargain prices. Buy our popular new junior base-metals stocks report today!
The bottom line is copper is drenched in greed, extremely overbought
technically, and bucking its underlying bearish fundamentals. Each one of these developments alone
is certainly enough to spark a major correction, but all of them happening
simultaneously virtually guarantees one.
Copper traders have been distracted by the stock markets’
levitation act, but once it fails the reckoning will come quickly.
When the SPX cracks, its stranglehold on traders’ imaginations
will vanish. Newly-awakened
traders in all kinds of markets, including copper, will return to focusing on
their own individual technicals and fundamentals. The resulting sharp correction in
copper to reflect its massive stockpile builds is going to create the best
buying opportunity in base-metals stocks since their panic lows. Be ready.
Adam Hamilton, CPA
Zealllc.com
January 8, 2010
Also
by Adam Hamilton
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