Tis the season… for copper? Its recent low near $3 per pound back in June and steady rise since then seem to fit very nicely with an annual pattern that coincides remarkably well with the annual construction cycle. Fitting, since copper’s number one use is in electrical wiring and piping.
If that pattern holds true this time around, then we are currently in the middle part of a run higher that should continue into the spring.
But aren’t economic slowdowns around the globe still hampering demand for metals of all kinds? Aren’t copper stockpiles in the process of replenishment, with surpluses projected for the foreseeable future? Add to that an overwhelming number of short positions on copper futures contracts, and prices can only go lower from here, right?
Maybe not. Stock replenishment and short positions can often be triggers for surprising upward moves.
Copper Under Pressure
Two key factors are expected to negatively influence the copper price over the near term. Firstly, there is still an awful lot of uncertainty regarding the global economic recovery, especially for the world’s largest consumers of copper – China and the U.S.A. Lower premium prices for bonded copper in Shanghai, for instance, are raising concerns over softer copper demand going forward.
In the U.S., economists and traders are awaiting key reports over the next couple of days to see where the American recovery stands. “The third-quarter U.S. GDP figures and the labor market report should give us further indications of the state of the U.S. economy and the next steps to be taken by the Fed when they are published on Thursday and Friday, respectively,” Commerzbank analysts explained in a note obtained by Reuters.
Stimulus from the Federal Reserve has supported the housing market and spurred activity in construction. Strong economic reports going forward could prompt the Fed to begin the much anticipated tapering of its monthly bond purchases, which could slow housing and construction, thereby pushing copper prices lower.
What is more, seeing as the copper price is just now at the tip of a pennant formation means that it is poised like a tiger waiting to pounce on any news… leaping higher if the news is positive, or dropping fast if the news is negative.
The second factor disheartening traders is copper’s elevated stockpiles. China has been restocking its inventory, which applies downward pressure on the copper price due to a readily usable supply. “The fact that the market knows that there has been restocking is why prices are weak now,” Nic Brown, head of commodities research at Natixis, informed Reuters. “If it wasn't for the increase in Chinese stockpiles, copper prices would be a lot higher.”
In fact, copper stockpiles worldwide are on the rise, creating a surplus that is expected to reach 182,000 tons this year and 328,000 tons in 2014. “There's a lot of forces at play pushing down on copper prices, such as prospects for rising supply,” Tim Radford at Sydney-based advisory Rivkin reaffirmed to Reuters.
As a result, there has been an increased shorting of copper future contracts in anticipation of lower prices. “Copper prices are being driven down by traders shorting the market on the view that too much supply will be coming on, such as from Rio Tinto's (NYSE: RIO) Oyu Tolgoi mine, and scrap metal supplies in China,” Andrew Michelmore, CEO of Chinese metals producer MMG Ltd., assessed to Reuters.
Subject to Interpretation
Yet these very same factors which traders are taking as bearish signs for copper over the immediate term could also be seen as bullish over the medium term.
For let us reason… why would China be stockpiling? With a three to four month lead time in procuring construction materials, it looks like China is gearing up for a robust 2014 construction season, which Michelmore believes will see an increase in Chinese copper consumption.
“I think it's going to take another six to 12 months to pick up,” he predicts to Reuters. “But certainly confidence is improving with the new government,” Michelmore adds, referencing the government’s initiative to provide new housing for millions of migrants moving from farms to cities.
Chinese research firm Antaike's chief copper analyst Yang Changhua informed Reuters that “refined metal demand from manufacturers of copper tubes, widely used in home appliances and cooling systems, had been stronger than expected this year and is expected to be steady in 2014.”
Including other government projects in the electric power sector, China’s demand for copper is expected to increase by 6.5% in 2014, which would give China a supply shortage of 1.9 million tons next year, higher than 2013’s shortfall. This higher rate of copper consumption, therefore, would lessen the impact of new ore mined. “I think the market's probably overestimating the rate at which supply's going to come on,” Michelmore opines.
Thus, the start of the new construction season in a few months’ time could start a new up-leg in the copper price, which would be amplified by the rapid covering of all those short futures positions currently in the system.
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Copper’s Link to the Construction Cycle
Given the construction industry’s heavy dependence on copper for wiring and piping, it comes as no surprise that the copper price would follow a repeating pattern that coincides with construction’s seasonality, as noted in the monthly graph below.
Construction is strongest from the spring to the autumn, which in the Northern Hemisphere (where the majority of people lives) corresponds to the March-October period. Allowing for three or four months of lead time in procuring supplies, we might expect surges in copper prices from about October to March, followed by lower prices toward a late summer bottom.
This is precisely the pattern seen in the graph above (with the exception of 2009, which saw demand rise all year long as nations began exiting the 2008 crisis). Rallies in the copper price (green) typically run from pre-construction months to mid-construction months, while pullbacks (red) usually begin mid-way through the construction season as supplies are pretty much fully purchased by then.
Just about right on cue, the copper price has been rising off of its 2013 low of $3 a pound this past June, and it has been rising throughout the autumn so far. Should this year follow the typical cycle, we should see higher prices continue into the spring.
Easiest Ways to Trade Copper
While still a relatively new market for the average trader, copper ETFs offer a great way of trading the metal at considerably less risk than futures contracts. Two excellent choices among others are:
iPath Dow Jones UBS Copper Subindex Total Return ETN (NYSE: JJC) – As Yahoo! Finance describes, “The investment seeks results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones-UBS Copper Total Return Sub-Index… The index is composed of Copper High Grade futures contracts traded on the New York Commodities Exchange.”
First Trust ISE Global Copper Index Fund (NASDAQ: CU) – As Yahoo! Finance outlines, the fund tracks “the ISE Global Copper Index” and is “designed to provide a benchmark for investors interested in tracking public companies that are active in the copper mining business.”
Thus, while JJC is a direct investment in the copper metal itself, CU is an investment in copper mining companies. As a result, CU pays a quarterly dividend collected from its stock holdings, which currently yields about 3.5% annually, while JJC pays no dividend.
Although the seasonal trade is calling for a higher copper price into the spring, macroeconomic conditions such as the global economic recovery – in addition to more local recoveries in individual countries – can either trump or accelerate that seasonal cycle. So prices can still drop lower going forward.
Yet any pullback will likely present investors an excellent buying opportunity, since at some point recovery will happen, with construction being an instrumental part of recoveries and copper being an instrumental part of construction.
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