Copper is frequently referred to as the economist of the metal markets. This is because copper is used in nearly everything that’s made. If it’s not in the final product, it’s certainly in the production facilities and the machines used to make it. Therefore, one assumes that the more copper a business or country buys, the more production they see in their near future. This is part of the reason copper has such a high correlation with rising stock markets. In fact, the correlation relationship between the copper market and the S&P 500 hasn’t been negative since the financial meltdown in early 2009.
The copper market made an all time high in January of 2011 at $4.7735 per pound. Since then, the market has consolidated primarily between $3.25 and $4 per pound. The consolidation continues to tighten and can be easily seen on a weekly chart as the trend lines that define the highs and lows continue to converge. The news will tell you that the reason the market is in limbo is due to the fiscal cliff negotiations and that once a deal is struck, the market will see enough of the estimated $2.5 trillion pent up dollars in the domestic corporate coffers to push it back beyond its highs.
I would suggest an alternative scenario in that the copper market has been fueled by growth overseas in developing markets and that it may have run its course for the near term. The top performing stock market for 2012 is Turkey. Their market is up nearly 50% for the year. Much of their success has been due to their ability to create a stable and labor friendly manufacturing center. Rounding out the top ten for the year are – Pakistan, Philippines, Thailand, Estonia, Nigeria, Kenya, Denmark, Germany and India, respectively. Germany is the only G7 country on the list and India is the only one of the BRIC’s to make the list. Clearly, this has been a good year for developing countries.
Digging deeper into the numbers behind the copper market we find some signs that the market price may not be supported by the development of the aforementioned economies. In fact, the deeper we dig, the more it looks like the market is being propped up by inflation expectations and speculative purchases. The main issues are the Chinese and U.S. economies since they are the number one and two copper consumers in the world, respectively.
Commercial traders have sold more than 12,000 contracts, about 25% of their position, over the last month and now hold the smallest net long position since late April. This selling has been enough to turn commercial traders’ momentum negative and set up a sell signal as the last bit of this rally has been driven by speculators and index funds.
This type of behavior is typical of a market that is moving sideways. Speculative participants tend to be buyers at the highs and sellers at the lows for two primary reasons. First of all, they’re afraid to miss the next big move. Secondly, they can’t match the commercial traders’ staying power and end up forced out of the market every time the market looks like it’s about to fall. This is exactly why we use the commercial traders to signal which side of the market we should be on and then use the speculators to create a bounce to sell or a dip to buy within the context of our overall outlook.
That being said, we will be looking for opportunities to sell March copper futures on any speculative rallies that stop short of the downward sloping trend line from the January 2011 highs, which now comes in at $3.7330 on the weekly chart. We’ll maintain this stance as long as commercial traders continue their selling pressure as we believe that is what will ultimately force the speculators to abandon their long positions.
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