by: Gary Dorsch
June 11, 2010
Copper is often referred to as the metal with a PhD in macroeconomics, since it finds its way into so many industrial applications, including automobiles, appliances, airplanes, pipes, wires, and even computer chips, to mention just a few of its uses. It acts as a top forecaster of where the global economy is heading next, especially China, the world’s economic locomotive. As such, copper is a favorite commodity for speculators in the markets, given its cyclical nature, and its volatility.
Copper has been on a wild roller coaster ride over the past several years, famous for its boom and bust cycles. Gambling on copper’s next major move is always a high stakes bet. But Jesse Livermore, the world’s most famous trader, observed:
In the long run commodity prices are governed but by one law -- the economic law of demand and supply. The business of the trader in commodities is simply to get facts about the demand and the supply, present and prospective.
It may be possible to use fictitious arguments for or against a certain trend in a commodity market; but success will be only temporary, for in the end, the facts are bound to prevail, so that a trader gets dividends on study and observation, as he does in a regular business. He can watch and weigh conditions, and he knows as much about it as anyone else. He does not indulge in guesses about a dozen things. It always appealed to me trading in commodities.
However, the copper market wasn’t observing the basic laws of supply and demand in 2009, when it gained 140-percent. Instead, copper dealers found it profitable to strictly focus on the demand side of the equation, and largely ignore the supply side. After all, “the market value of any commodity is only worth, what the highest bidder is willing to pay.” What matters most is China’s demand for the red metal, since it single-handedly buys about 35% of the global supply.
Commodity traders were questioning whether Professor Copper had actually earned his degree in Economics. Copper prices soared by 60% to as high as $7,600 /ton, in the second half of 2009, despite a big build-up of the supply in London warehouses and inventories in the Shanghai Futures Exchange, which rose to 114,300-tons, - the highest in six years. Typically, rising inventories are a sign of supply outstripping demand and is taken as a bearish signal. Yet the build-up of supply couldn’t put a dent in copper’s mettle.
Copper traders said the bullish view was justified, because the warehousing of base metals, and the financing of miners, had become increasingly intertwined. Investment bankers discovered a new way to earn millions of dollars, by buying the metal cheaply in the cash market, and selling it forward at higher prices, - thus earning the difference. Much of the build-up of copper supplies in LME warehouses was linked to contango financing, and already earmarked for future delivery.
Indeed, copper prices continued to soar toward $8,000 /ton, fueled by China’s $586 billion spending spree on infrastructure projects. China bought 3.9 million tons in the first 11 months of 2009, up 67% from the same period a year earlier. Chinese alone accounted for 43% of the world’s total demand for all base metals. Take China out of the equation, and global demand for metals fell 9%. Heading into 2010, it was assumed that China would continue to buy 35% of this year’s copper supply, estimated to reach about 19-million tons.
Chile’s Mining Minister Santiago Gonzalez wasn’t swayed by the logic of the “contango” theory, and warned on Jan 11, that copper prices could see an “important” downward correction. He said:
We are worried that stock levels are climbing higher. We are at 700,000-tons at the moment, while prices remain high. This means that at any minute we could see a violent change and prices could fall.
Gonzalez noted that Chile’s state-run Codelco, the world’s top miner of copper, had just reached a record high output of over 1.7 million tons in 2009.
The first cracks in the copper rally began to appear on January 13th, only two days after Gonzalez warned of a sharp decline. However, Gonzalez’s timing had the benefit of pure luck. The People’s Bank of China (PBoC) suddenly shifted to Quantitative Tightening (QT), and hiked bank reserve ratios a quarter-point to 16%, effectively draining 300 billion yuan out of the Shanghai money markets. The PBoC’s shift to QT was prompted by a surge in bank lending that was flooding the economy with yuan, inflating a bubble in real estate, and risking a surge in inflation.
The January 13th hike in bank reserve ratios was the first of three such tightening moves that eventually lifted the ratio to 17% on May 3rd. The copper market remained defiant however in the face of the PBoC’s tightening moves in February and March, flexing its muscles for one last fling to $8,025 /tons on April 12th. China’s economy was booming at a 12% annualized clip, and few traders could conceive of a bearish reason to sell the red-metal, beyond the inclination to grab profits.
“A trend in motion will stay in motion, until some major outside force, knocks it off its course.” Indeed, copper has tumbled more than 20% in a span of two months, and on track for its biggest sustained loss since the height of the global financial crisis in late 2008. King copper was broadsided after receiving a powerful jolt from an obscure and thinly traded market linked to Greek bonds, called credit default swaps (CDS), which aren’t on the radar screens of many traders.
Traders in the CDS markets had exposed the truth about Greece, that it’s technically insolvent, and unable to repay its €300-billion of debt, without a helping hand. When S&P downgraded Greece’s bonds by three-notches to BB+, or junk status on April 27th, Greek bond 2-year yields soared to as high as 26%, and the bottom began to fall out from under the once unshakeable copper market. European banks hold around $272-billion in Greek public and private debt, and for traders in the copper market, the extreme volatility in the Greek bond and CDS markets simply meant it was time to “sell now, and ask questions later.”
The EU’s equivalent of “shock and awe” – a €750-billion package of standby funds and loan guarantees, has enabled the eurozone banks to survive yet another near death experience. Still, on May 31st, the ECB warned that eurozone banks would face a new wave of potential loan losses - up to €195-billion over the next 18-months, from loans extended to the private sector, that are going sour.
Thus, although the specter of a sovereign bond default has been postponed for a later date, the next lethal phase of the European debt crisis is now materializing, - a frightful situation where European banks become unwilling to lend money to the private sector. There are latent fears of a eurozone “credit crunch,” looming on the horizon that could suffocate the $14-trillion eurozone economy, and in turn, weaken demand for industrial commodities, including copper and other base metals.
Eurozone banks are hoarding a record amount of cash, and buying German, French, and Swiss government bonds, and gold, rather than lending euros to the private sector. As liquidity dries-up, the credit default swap for the eurozone’s top-50 junk bond index, of lesser credit worthy companies, has become a key benchmark for measuring the risk of a “credit crunch.” Each upward surge in eurozone junk bond CDS rates has ignited a knee-jerk sell-off in the copper market. (Conversely, each decline in CDS junk bond rates has given a boost to the red-metal.)
If there is a silver lining to the eurozone debt crisis, it’s the slide in the euro against the US dollar to a four-year low of $1.200, which has helped to lower the cost of imports of key industrial commodities, such as crude oil, copper, and iron ore. China said the cost of its imports fell 5% in May to $112 billion, largely due to the drop in commodity costs. China’s import bill for copper ore and products fell 9.1% in the month of May, to 396,712 tons, after a 4.4% slide to 436,345 tons in April, as the country began drawing down on 100,000-tons of supply in Shanghai warehouses.
The euro tumbled below $1.200, skidding to a four-year low, after the European Central Bank said it would print vast quantities of euros, in order to finance the purchase of eurozone government bonds. The ECB’s lack of clarity over the size of its printing operations has left the euro vulnerable to speculative attack, and a loss of confidence among central banks, who hold more than $2-trillion of the common currency. Whereas the ECB’s monetization of sovereign debt has been a bullish factor elevating gold to record heights, base metals such as copper and nickel, have been weighed down by a weaker euro /dollar.
However, in the aftermath of copper’s 20% correction from its recent highs, to as low as $2.75 /pound in New York, bargain hunters and contrarians, are betting on a rebound for copper, on ideas that the euro can ultimately stabilize above the psychological $1.20-level. There’s also evidence that China’s economy is still growing strongly, after Beijing reported that its exports rose 10% in May, to $131.7-billion.
Freeport McMoRan Copper & Gold (FCX), the world’s largest publicly traded copper miner, tumbled 32% from its highs set in mid-April, closing tracking the slide of the copper futures markets and Shanghai red-chips. It’s been all downhill for FCX, since it posted stellar earnings of $897-million in the first quarter, and announced a doubling of its dividend to $1.20 /share. The latest catalysts behind FCX’s latest slide, are fears of a debilitating “credit crunch” in Europe, and worries that China’s central bank will continue to tighten monetary policy, and burst the housing bubble, which in turn, would stifle construction activity and demand for copper.
Highly volatile markets tend to overshoot on the downside and the upside, and markets don’t travel in a straight line. There are always zig-zags along the way, - which are typical of the normal ebb-and-flows of a market. After a substantial sharp decline, it’s only natural for bargain hunters to feel the urge to acquire battered shares in the stock market, and for bona-fide end-users of commodities, to leap into the arena, and buy raw materials at cheaper prices. Warren Buffett said:
The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.
FCX is a crown jewel among metal miners, and a speculative favorite, because it’s a hybrid between a copper and a gold miner. Its fourth-quarter mining costs for copper averaged 62-cents per pound, a big reduction from $1.04 per pound a year earlier. Looking ahead for 2010, FCX expects sales of about 3.8-billion pounds of copper, 1.8-million ounces of gold, and 60-million pounds of molybdenum. Freeport is investing $1.8-billion in its Tenke Fungurume project in the Congo, which is set to produce 250-million pounds of copper and 18-million pounds of cobalt a year.
Still, despite its very impressive credentials, FCX remains hostage to cyclical swings in the global economy, the whims of G-20 central bankers, and gyrations in the US-dollar and Shanghai red-chips, all intertwined within a hotbed of speculation. On June 9th, the World Bank warned a “double-dip” global recession could not be ruled out, if traders lose faith in Europe’s bailout scheme, adding a prolonged period of rising sovereign debt could lift interest rates, and curtail investment and growth in emerging markets. The next day, operators in the global stock markets ignored the World Bank’s warning, reckoning it was a contrarian buy signal. In any event, copper is the first place to look for early clues about the health of global economy, and a great place for wagering bets.
Disclosure: No positions
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