Copper has enjoyed a spectacular run. In 2009, as it emerged out of the stock-panic-induced commodities price crash, it rocketed 153.2% higher! Over the same span, the flagship CCI commodities index only rallied 32.1%. And gold, which has captivated traders in recent months, was only up 24.3% in 2009. Copper even eclipsed 2009?s massive 86.3% gain in crude oil.
Firmer auto-sales figures are helping prompt copper buying. Also, after a period of redemptions, hedge funds are repositioning for the new year. In addition to investment flows coming into copper as 2010 kicks off, weather issues are hampering transportation and limiting scrap availability. Severe snowstorms in parts of China have raised concerns about transport disruption. This buying caught some participants off guard and prompted some repurchasing of previously sold positions. Chinese buying is also being fuelled by Shanghai Futures Exchange prices that are high enough above London Metal Exchange prices to make importing the metal more attractive. In recent sessions, supply issues have also buoyed prices.
At the same time, copper has become a Siamese twin to the S&P 500 Stock Index (SPX)! The technical chart patterns of copper and the SPX have become almost interchangeable. For the most part, copper has been rallying when the SPX is strong and retreating when the SPX is weak. Since the SPX bottomed on March 9, 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!
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.
The base metals traded on the LME 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 LME stockpiles offer outstanding insights into copper supply and demand.
It is often stated that if copper, which is used in commercial & residential buildings, electronics and automobiles, is surging, then all must be right in the world and in the economy, too. But there appears to be a disconnect from reality as strength in copper generally occurs late in the economic cycle, and the relationship between price rises in copper and the beginning of a new economic cycle is not so substantial as it?s made out to be. Of the six recessions since 1974, the current recession would be the only one that would see copper prices acting as a leading indicator.
Another explanation tossed about to explain copper?s rise is that the Fed?s easy monetary policies will lead to inflation, and copper is only anticipating these coming changes. But the fact remains that there is a very poor correlation between higher copper prices and inflationary expectations. Of the five bull runs in copper since 1974, only two were associated with any real significant inflationary pressures, and these were in the 1970s. Recessions by definition are deflationary, and one would normally not expect copper prices to rise in the current de-leveraging, deflationary environment.
In the early years of the baby boom era (1946 to early 1960s), copper prices rallied smartly. And drop in copper prices often signalled an imminent recession. When copper prices peaked, that peak usually coincided with a peak in economic activity. During the years before the Asian economic crisis, copper prices were quite strong as booming Asian and Latin American economies boosted demand. Many of the newly industrialised Asian countries had vibrant technology sectors that were rapidly increasing their output of computers and technology goods. Copper is used abundantly in the manufacture of computers and related products. Copper prices rose until the summer when the first signs of the crisis began to emerge. The devaluation of the Thai baht sent the first signal that Asia?s high-flying economies were in danger of collapsing. A nearly simultaneous decline in the price of copper was an early warning signal that the global economy was topped with a copper roof.
In the aftermath of the Asian crisis, copper prices collapsed in 1998. A pound of copper, which sold for as much as $1.40 in mid-1997, crashed to $0.68 in a matter of months. The plunge in copper prices was accompanied by a disastrous decline in the prices of many other commodities. The 50% decline in key industrial commodity prices told the world that a significant economic event was taking place around the world. Since the ratio of copper has reduced of late, it no longer has such a strong predictive power, but the relationship between copper prices and economic cycles is worth paying attention to.
After smoothing out cyclical and seasonality factors, copper prices tend to generally peak just before a recession begins and recover just before the commencement of subsequent recovery, thus leading to the notion that the economy was ?topped with a copper roof?. There are other reasons to doubt the copper rally?s staying power. Much of the supposed incremental demand for copper is still more theoretical than real, allowing inventories to recover smartly since last summer, when record Chinese stockpiling slowed. US data suggest that modest recoveries in homebuilding and auto production are underway, both bullish indicators. But these, along with an improbable continuation of China?s building boom, are already baked into prices.
More than a modicum of speculative froth is apparent. Near-month futures are in contango, when more distant contracts are dearer, indicating a well-supplied physical spot market. It is also a sign that copper may be attracting relatively more financial owners, like index funds, rather than end-users. At the same time, global prices for some metals may continue to spike in 2010 if workers demand better packages and strike at key operations. While 2010 is not a big year for major contract expiries?the main indicator for potential labour disruptions? there are still a few in copper, which may see a strike.
In Chile, the favourable terms in the wage deal won by workers at Escondida, the world?s biggest copper mine, have raised expectations. Xstrata?s copper refinery in Montreal will see a contract expire at the end of May. The main strike risk in wage negotiations is at Collahuasi, where the contract expires on November 30. Contracts expire on that date at three other Chilean operations. Most of Mexico?s miners under the national mining and metals workers union have been on strike at the country?s largest copper mine, Cananea.
The author is a Wharton Business School MBA and CEO, Global Money Investor