Is a Copper Collapse Coming – What You Need to Know

Copper Collapse Coming? What You Need To Know

Pacifica Partners’ Financial Post Weekly Column – February 5th 2010

This and other articles also available online at: Financial Post & Investment Waves Blog

Copper is often called “Dr. Copper” because of its ability to turn higher or lower in advance of turns in the broader economy. It almost seems like it has a Ph.D in economics – hence the moniker. Thus, some investors use copper prices as a sort of thermometer to get a sense of where the economy is headed. But when it comes to explaining the powerful momentum behind copper prices, most economists might be chagrined to find out that the laws of supply and demand do not seem to be working.

Many observers seem content to just offer “Chinese consumption” as an explanation for all things related to commodity price increases and leave it at that. Over time, we have tried to highlight the weaknesses of this blanket explanation.
There seems to be a large amount of data that shows Chinese copper purchases are ending up as inventory for future use or speculators are building positions for investment purposes.

Last year, we devoted our July 30th comments in this space to an article titled: ”China: Do Risks Outweigh the Rewards (Again)?” Only five days later, the Chinese stock market topped out and has lost almost 20% of its value since then. We have felt that investors are not looking at the whole picture when it comes to commodities and the risks are real.

Just recently, Bloomberg quoted David Trelkeld, a 40 year veteran of the copper trading markets, as saying that about 90% of the buying in copper has been by speculators – including exchange traded funds (ETFs) which investors can buy as a way to gain exposure to the commodity. His call is for copper prices to plunge to levels that would essentially crash copper stocks. According to Threlkeld, “We’re going to see a catastrophe in the market.”

The first chart shows that the rise in copper inventories (orange line) has seemingly gone unnoticed by the markets. The price of copper has continued to rise unchecked. Threlkeld indicated that there are approximately 3 million tons of unreported copper inventories in China.

Copper China Supply & Demand

(Click on chart to enlarge)

Source: Bloomberg, Newedge Canada Inc.

While China imported over 3.2 million tons of copper last year, Threlkeld believes that “The way the figures are being reported is anything that’s shipped to China is assumed to be consumed, which is clearly ridiculous”. Inventory levels on the Shanghai Futures Exchange have also more than tripled over the last year and are up almost 50% on the London Metals Exchange for that same time period.

This is especially interesting given that Chinese monetary policy is starting to tighten in order to bring about some semblance of order to speculation in land prices and the continuation of the construction of more industrial capacity – while there are already large amounts of overcapacity in many industries. It would not be surprising that should this forecast come to pass due to the fact that supply and demand start to mean something again – then copper producers will have to start to reduce output.

As the chart below shows, during the initial phase of the commodities bull market, copper prices outperformed the US stock market as measured by the S&P 500. The trend line that was in place from 2002 to 2008 was broken and copper prices began to underperform the US stock market. As copper prices regained considerable momentum from early 2009, they have not been able to rise above the old trend line.

Copper versus the S&P 500

(Click on chart to enlarge)

For investors who are overweight stocks in their portfolios, perhaps some prudent trimming might be just what the “Dr.” ordered.

Pacifica Partners Capital Management

Pacifica Partners Capital Management
Suite 213 5455 152nd St
Surrey, BC, Canada
V3S 5A5

Tel: 6o4.576.8908
Tol Free: 1.877.576.8908
Fax: 6o4.574.2096

Twitter: Follow us

Pacifica Partners Capital Management

Legal Disclaimer

This report is for information purposes only and is neither a solicitation for the purchase of securities nor an offer of securities. The information contained in this report has been compiled from sources we believe to be reliable, however, we make no guarantee, representation or warranty, expressed or implied, as to such information’s accuracy or completeness. All opinions and estimates contained in this report, whether or not our own, are based on assumptions we believe to be reasonable as of the date of the report and are subject to change without notice. Past performance is not indicative of future performance. Please note that, as at the date of this report, our firm may hold positions in some of the companies mentioned.

AJ Sull, Chinese stock market, Pacifica Partners, S&P 500, Dr. Copper, monetary policy, copper prices, Chinese consumption, Copper Inventories

Copyright (C) 2010 Pacifica Partners Inc. All rights reserved.

View All
Start a Conversation