Just days ago, the Securities and Exchange Commission approved JPMorgan's request to issue the first ETF in the U.S. that will be allowed to buy and hold physical copper. The fund's approval comes after heated debate on the issue as there were numerous complaints from merchants and fabricators that the ETF will lead to a shortage of metal. Following this, expectations have grown that the Physical Copper ETF proposed by BlackRock will also receive approval.
According to the FT, JPMorgan's regulatory filing suggests that the fund could hold 61,800 tons, which equates to about 27% of the copper held in the London Metal Exchange's global warehouses. Additionally, the proposed BlackRock ETF would, according to reports, hold about 121,200 tons. Assuming that BlackRock's ETF receives approval, the total amount of copper held by these new ETF's would be 183,000 tons. Based on current copper prices around $8,000 per ton, the total value of the combined ETFs would be just under $1.5 billion.
One major question is what level of demand actually exists for a physical copper ETF? Already, two physical-backed copper products trade in Europe: ETFS Physical Copper (PHCU) and DB Physical Copper ETC. So far neither product has taken off. Combined, these products hold only a few thousand tons of metal. Given this, it is difficult to say that a similar product launched in the U.S. would generate vastly more demand. That being said, for the sake of relevance for the rest of this article, let's assume that demand in the U.S. for physical copper ETFs is strong. After all, both JPMorgan and BlackRock have likely done significant market research that leads them to believe that demand for this product exists. Also, both JPMorgan and BlackRock are in a unique position to market the products to through their investment advisory businesses.
Copper Market Impact
The most important driver of copper prices is China. While getting specific data regarding the current warehouse supply of copper in China is difficult, it is not difficult to get the general picture. Often, reports are published discussing the vast amount of copper stockpiles in China. It is difficult to say exactly how much copper China has stockpiled, however, it is safe to say that the Chinese stockpile is significantly larger than LME and COMEX warehouse inventories combined. While China is probably the most important force driving copper prices, it is not the only force. Other factors such as occasional mining strikes, the improving U.S. economy (notably the housing sector), and central bank policies such as QE can outweigh China in the short-term.
Interestingly, the International Copper Study Group (ICSG) has said that 2013 will likely be the first year in four years that global copper production exceeds demand. Perhaps, this is a result of the prolonged period of higher prices for copper over the past four years leading to increased mining production. In summary, I think it is unfair to say that these ETFs will directly, on their own, lead to a squeeze higher in copper prices. I am not saying that, given the right circumstances, a squeeze could not occur. Given a recovery in China, more expansive monetary policy, or significant production shortfall, the effect of the physical ETFs entering the market could lead to a spike in prices.
Existing Copper Plays
iPath Dow Jones-UBS Copper Total Return Sub Index ETN (JJC)
Right now, JJC is the most popular play for investors and traders looking to make direct bets on copper prices through an exchange traded vehicle. I expect JJC to be one of the big losers from the physical copper ETFs as liquidity will likely leave JJC for the new ETFs. There are a few reasons for this. Firstly, JJC is an ETN, not an ETF, meaning that investors in the new ETF will not have credit exposure to the sponsoring financial institution as is the case with ETNs. Also, the new physical ETFs will likely be larger, lending themselves to more highly capitalized traders. It is important to note that there should be little to no impact on JJC valuations as the metrics used to value JJC will remain unchanged. Rather, I expect the ramifications to be felt in terms of liquidity for JJC.
Freeport McMoran (FCX)
For a long time, FCX was considered to be one of the best ways to get exposure to copper. However, with FCX's recent acquisitions in the oil patch, this is no longer the case. Following the news of the acquisitions, FCX shares fell by 16%. The selling occurred for a variety of reasons but one group of sellers was likely those who had owned FCX as a pure copper play. While FCX previous had some gold exposure, the company was largely considered as close to a pure play on copper as existed. Going forward, FCX is now turning into something of a commodity conglomerate similar to BHP Billiton (BHP). Thus, I expect the new physical copper ETFs to have little impact on FCX as investors who own FCX are looking for more than a play on copper. Many of those who were in FCX as a copper play have exited following the oil deals. However, there are likely still some investors who will switch out of FCX and into a physical copper ETF given the chance.
Southern Copper (SCCO)
FCX's pain has been SCCO's gain. Investors looking for a pure play on copper seem to have rotated out of FCX and into SCCO. Given this move, SCCO shares could be at least somewhat negatively affected by the launch of physical copper ETFs. This is especially true as SCCO has had its fair share of mining problems of late. Mining strikes are a good example of reasons why investors looking to express a position on copper are better served using the new physical ETFs as opposed to SCCO. On the other hand, SCCO does offer a near 10% dividend yield.
It is difficult to say how much impact physical copper ETFs will have on copper prices. However, I do think it is safe to say that the impact of China either bottoming or not will outweigh the arrival of physical copper ETFs. Perhaps, if the stars align for the bulls (i.e china recovers at the same time ETF launches), the launch of physical ETFs will generate something of a squeeze. At this point, I don't think FCX shareholders have much to worry about in terms of competition from the new products as FCX is no longer considered the copper pure play. Comparably, SCCO shareholders may have more to worry about.