Tuesday, March 8, 2011

This is not the copper you are looking for

Edit: A followup to my bearish copper case was posted on 09/27/11

Copper has had quite a run, but is it legit?  Numerous experts are calling for continued strength in the commodity as well as continued supply deficits.  I offer a contrary opinion.

There are several fundamental reasons for this alternate opinion and we'll go over them.   From a technical standpoint copper as well almost all other commodities has been on a tear upwards ever since the announcement of QE 2.  Recent events in the Middle East have slowed the rise in prices and higher oil prices may dent future economic growth worldwide so forces may be aligned to drive copper down in the near future.

Chinese Copper Demand
Copper is traded worldwide on several exchanges and as such provides an opportunity to see where prices (and by implication demand) are higher.

China is commonly cited as a source of continued copper demand.  If this is so one would think copper sells at a premium to elsewhere in the world.  This is not the case and copper has been selling at a discount to the LME (London Metal Exchange) for several months.  As you can see here the last time couple times Chinese copper was cheaper worldwide prices stopped going up.  (ht news-to-use.com )

One can see the real time arbitrage price difference on Bloomberg. While the arbitrage values do swing between positive and negative, since mid July the arbitrage price has been negative.  Take a look at the long term trends and you'll see periods of negative arbitrage have coincided in the past with lower future prices as well as increasing inventory levels.

One of the common bullish themes is how copper has been in a deficit for several years and will continue to be so in the future. A long term inventory chart provides some clarity.  Longer term copper inventories have been both lower and higher than today.  While right now copper inventories are dropping on a year over year basis the last inventory peak was in early February 2010 and as you can see inventories tend to trend in one direction or another for a period of several months.  Right now we are on an upswing. Copper inventories (LME, SHFE,  Comex) bottomed mid December and have risen nearly 130,000 thousand tonnes since then and are rising at over one thousand tonnes a day right now.

Furthermore the number of cancelled warrants continues to drop and has remained well below 20,000 for several weeks now.  A low cancelled warrant number is an indication of fewer lots of copper coming out of inventory for delivery.

The dog that did not bark
A most interesting news article ran across Bloomberg late last year regarding Shanghai and bonded warehouses.


Why provide this option of delivering copper from 'non official inventory' warehouses if it did not already exist?  While getting hard numbers about how much hidden inventory exists is nearly impossible, this rule change leads one to believe there is significant supply available, otherwise why provide the option?

Furthermore the 'movement' of inventories into and out of the official stockpiles occurs rather easily.  In January aluminum inventories went up 100,000 tonnes in one day.
http://traderightuk.wordpress.com/2011/01/10/now-you-dont-now-you-see-it/  100 thousand tonnes is a LOT of material. The largest ships in the world move 150 thousand tonnes of cargo to give you a sense of the mass involved.

Just because you can't see the copper (or aluminum) doesn't mean it is not there.  There are other quantitative numbers showing us there is a lack of demand in China such as the the lower relative price as well as a lack of imports.

Both refined and scrap copper imports have leveled off over the last few years and do not show a sustained rise in imports as one would expect if China is truly the voracious eater of copper as people have posited. 

Four dollar copper does wonders for encouraging more supply.  Heck, there's even supply developing underwater.  Nautilus minerals is currently building an underwater 'mine' and if they can pull it off the potential is huge.  

Furthermore a  little corruption goes a long way.  There's a 17% VAT tax on copper in China.  Does one honestly believe there is no skirting of the law?  A truckload of copper would be an easy thing to 'misplace' at a large import facility.  

Betting against the house
Looking at copper futures over the past several years one can see (green line) how commercial traders have never been this short as they have been during this recent run up in price. Remember when you are buying copper right now the person selling probably has more information about copper prices than you do.

Avoiding Imperial Entanglements and Bernankflation
Almost all commodities have been on an tear upwards since Ben Bernanke announced QE 2 in late 2010.  The results have come home to roost however as higher food prices may have been the spark that set off the political unrest in the Middle East.   Higher oil prices from the riots and regime change in Tunisia, Egypt, and Libya have people wondering who is next and what will that do to oil supplies.  Oil prices are now well above $100 a barrel and that price shock has yet to be fully realized throughout the world economy.   To hedge my short base metals position I'm also long precious metals and this combination has worked out well recently.  Continued tension in the oil producing nations will most likely keep gold rising and depress copper prices as people grow concerned about future economic growth.

Alternative learning annex
For those of you who can't stand looking at data and trying to understand the nuances of localized supply and demand I have created a short video explaining the high points of this post.

http://www.youtube.com/watch?v=OoFQQlBWcOk (YouTube version)

Further reading:
Bearish calls:

More supply on the way:
http://www.reuters.com/article/2011/01/13/chile-codelco-investment-idUSN1328075420110113?feedType=RSS&feedName=everything&virtualBrandChannel=11563 -- 16 Billion for Codelco alone

Other base metals not doing so hot on a fundamental or technical level.

Financialization of commodities and correlation to equity markets.

http://www.cochilco.cl/english/productos/estadisticas.asp - Long term copper stats from Chile

Chinese copper imports:

The author is short base metals and long precious metals.


  1. Are you aware that JP Morgan is the copper market?

    The entire commodities index is about to go upwards because of inflation, sorry to say... it's all manipulated by the big banks...
    I did like your article though, but don't necessarily agree with it.

  2. Brilliant. There are only so many monorails that Chinese pig farmers can construct. When this (Bernankified) commodity bubble bursts it is going to be a real beauty.

    Perhaps you can educate Krugman on the crude oil market? He thinks there are no speculators and it's an "inelastic" supply/demand curve.

    Um, Paul, let me show you tankers full of oil that were parked during the period when prices were very low. Let me also show you these large rooms full of commodity traders over at UBS, Goldman, and there are also these entire firms that do nothing but trade energy futures all day.... you really should visit the real world occasionally, PK !

  3. I am aware of the JP Morgan size in the copper markets. I was saving that for part 2 of the bearish copper case.

    As for inflation, i'm sorry, but I just don't see it. Yes, Ben Bernanke has pumped up the commodity markets a bit and put a bid under stocks as well but if you look at wage growth in America its basically flat / declining. As oil prices go up the dollar going into the gas tank has to come from someplace and so the spending just gets shifted around. The train wreck that is the European union is coming unraveled and China is in the tightening phase of a monetary cycle.

    Remember I'm also long precious metals via the ETF GLTR so IF we do get inflation I'm still protected.

  4. @Leftback, thanks. There's more to this story on copper and more will be coming shortly.

  5. when using the finviz futures charts, you want to look to see what the "large traders" are doing, not the "commercial traders". you'll notice they're almost mirror images of each other- the latter are hedging.

    so, by that metric they are in fact incredibly bullish on copper. as well as gold, the euro, coffee.. basically everything not the dollar.

  6. @St. Deluise
    Yes, I see the COT report data has reversed itself recently with this drop in copper prices. I'll have a followup to the copper situation shortly.

  7. All I have to say right now is yeeeehaaawww!
    :) Copper is taking it on the nose right now.