Which Way Is Copper Going? Examining Contrary Opinions

Eric Fry By Eric Fry, Macro Strategist, The Oxford Club

Commodities

The financial markets are like a war. No matter which side is winning – the bulls or the bears – the other side will gain an occasional victory.

Sometimes these countertrend victories are so decisive that they change the course of the entire conflict. But not usually.

Instead, countertrend victories are usually just the fleeting glories of a lost cause. They are Robert E. Lee’s Chancellorsville or Sitting Bull’s Little Bighorn… or the short seller’s 2008.

But in the heat of battle, it is sometimes difficult to determine which side is actually winning the war. Such is the current state of the copper market.

Even though the bulls have been in control of this market for nearly two years, the bears win an occasional battle… and continue to predict a falling copper price.

Since hitting a six-year low of $1.94 a pound in early 2016, the price of copper has gained more than 50%. And yet, throughout this entire advance, naysayers and skeptics have doubted the durability of copper’s advance.

In July of last year, for example, when copper was selling for just $2.21 a pound, an article on FastMarkets declared, “The recent rally in base metal prices is not sustainable because it was technically led and not an accurate reflection of physical demand or supply.”

The article continued by citing the outlooks of two leading analysts…

“Metal markets are still soft so there is not a physical market prepared to support it,” said Vivienne Lloyd, senior base metal analyst at Macquarie Bank. “I would guess producers will be actively hedging in aluminum and copper – at the least.”

Société Générale analyst Robin Bhar said, “Physical buying was not responsible [for the uptick] – it was all speculative. CTAs [commodity trading advisors] covered to book profits or cut losses, and I can’t see an improvement in the fundamentals.”

Since these dire pronouncements, the copper price has soared 33%. But skeptics are lining up against copper once again, and they are predicting a sell-off… once again.

“Are Cracks Emerging in the Copper Rally?” a Wall Street Journal article recently asked.

“Analysts have cautioned for several weeks that speculative buying of the industrial metal has caused the rally to get ahead of supply-demand fundamentals,” the author leads off before citing a couple of bearish experts.

“Copper is the metal which looks most overbought,” JPMorgan analysts wrote.

Lloyd was featured again, saying, “We think the demand conditions will be much weaker next year.” The Journal author elaborated, “Ms. Lloyd said she wasn’t confident the construction strength seen this year can be maintained.”

Bull markets always face skeptical voices and bearish opinions. They wouldn’t be markets if they didn’t. We investors should not fear contrary opinions. Instead we should examine them for their validity.

At the moment, the copper bears are citing three main reasons for their outlook…

  • The Commitment of Traders report on copper from the U.S. Commodity Futures Trading Commission is signaling a “toppy market.”
  • Copper inventories are rising sharply.
  • Copper demand is waning.

If, in fact, all three of these assertions are true, the copper price should certainly fall. So let’s take a look at them one at a time.

First, the Commitment of Traders report. It shows that professional money managers have amassed their largest-ever long position in copper futures. In other words, these folks like copper a lot…

That’s definitely a warning sign. Whenever this particular group is leaning far to one side of a particular trade, it usually pays to take the other side of that trade… or at least to stand clear of it.

As a group, these investors are not exactly the “dumb money.” But they are certainly not the “smart money” either. I would call them the “flock money” because they tend to act like sheep, especially at the extremes of a particular market.

They flock toward the identical trade at the identical time. When that happens, as it has in the copper market, the trade becomes “crowded.” Then there are very few investors around left to buy into the trade and push its price higher. That’s when a reversal usually takes place.

So it would not be surprising to see a correction in the copper market that lasts several weeks. But duration is not synonymous with intensity. In other words, the unwinding of speculative long positions might last several weeks, but I doubt it will knock the copper price below about $2.75, which is where it was trading two months ago.

The second point that copper skeptics cite to support their bearish outlook is that “inventories are rising.” When the supply of any commodity is on the rise, the price of that commodity tends to fall… all else being equal.

It’s true that copper inventories at the COMEX here in the U.S. have jumped to a 13-year high. But COMEX inventories aren’t the entire story. They aren’t even half the story. In fact, they’re barely one-quarter of the story…

The Shanghai Futures Exchange holds about the same amount of copper inventories, while the London Metal Exchange (LME) holds nearly twice as much.

So to get a feel for what’s happening globally in the copper market, it’s helpful to track the combined inventories of the COMEX, Shanghai Futures Exchange and LME.

As the chart below shows, the current combined inventories of these three commodity exchanges have barely budged during the last few months. In fact, they are only marginally higher than their average levels of the last nine years. These inventory levels are worth watching, but they are very far from flashing amber.

The bears’ final argument is that demand for copper is waning.

It is a fact that current demand is not waning. So the prediction that future demand will drop is simply a guess. Perhaps this guess will come to pass, but there is scant evidence to support that outlook.

Copper demand has been ramping higher for months – both from traditional sources, like construction and electricity infrastructure, and from nontraditional sources, like electric vehicles (EVs), charging stations, and renewable power installations.

None of these copper-intensive industries are showing signs of fatigue. Rather, most of them are booming, which is why mining companies like Teck Resources and Glencore expect the copper supply deficit to increase significantly over the next few years.

So if we were to take all of the arguments from the copper bears and toss them into a blender with the copper market’s bullish long-term trends, we might end up with a scenario that goes something like this…

Near term, the copper price is susceptible to a significant correction – perhaps one that pulls the price from the $3.05 level down to $2.75 or below. But looking out over the next few years, copper demand is likely to remain robust… and grow rapidly.

The EV market alone is likely to power significantly larger demand for copper. Consider the fact that a single EV model – the Tesla Model 3 – receives 1,800 new orders per day. The rush for essential “electric metals” like copper has become so intense in the EV market that some car companies are talking openly about buying entire mines and/or mining companies.

At the Frankfurt Motor Show earlier this month, BMW head of procurement Markus Duesmann disclosed that the automaker is considering investing in mines in order to secure critical supplies of cobalt and other metals it uses in electric car batteries.

If BMW is anticipating supply-threatening demand for cobalt, the company must be anticipating strong demand for copper as well. The two go together. EVs contain about 10 times more copper than cobalt.

Bottom line: Copper is in a bull market, and its price will likely move higher over time. Even so, copper will suffer price corrections along the way. But unless and until serious bearish data points present themselves, the bull market in copper deserves the benefit of the doubt.

Good investing,

Eric