As discussed in "Impact of Global Economic Recovery and Chinese Growth on Copper," the recent gains in copper prices have been underpinned by the broader global recovery, as well as the continued fiscal growth of the world’s number one copper consumer; China.
There are two other major factors however, which have not only been helping to spur copper prices to the highest levels in two years, but also act as risk factors going forward, with the potential to at least curb the price appreciation brought about by economic growth - i.e. movements in the currency markets, and the impact of speculation and "paper accounts" (those where no physical commodity is held or traded).
Having considered the impact that the rapid growth in China, as well as future implications of any fiscal tightening measures may have on copper prices, there is another factor coming from the Asian giant that is set to have a strong impact on copper prices going forward. This is the recent news that the country may be relaxing price restrictions on their currency, expanding the band it can trade in while pegged with the US dollar. Depending on what measures China uses to curb its rapid growth, the yuan may feel some upward pressure compared to other global currencies. Any appreciation in the currency will make copper imports comparatively cheaper for Chinese consumers, while at the same time exports comparatively more expensive for the rest of the world.
Economically speaking, this trade deficit in copper will be supportive for global copper prices, effectively increasing global demand while decreasing global supply. This does all depend however on the extent to which the yuan will appreciate, if at all, compared to other currencies. At this stage, for example, any upward moves in the currency are expected to be limited, with China as yet not giving any indications that they will allow a fully free floating rate this year. However, going forward these currency moves will at least in some small part limit the bearish impact of any economic slowdown in China, in turn limiting any downward pressure felt by global copper prices.
This leads us on to the major currency factor that has been driving gains across commodities, and the one which offers some potential risk to a continued rally in copper prices, and that is the weakening in the US dollar. As with all dollar denominated commodities, the greenback has an inverse relationship with prices (stronger dollar means comparatively more expensive commodities for global economies, and therefore lower demand and lower price). The Trade Weighted Dollar Index (DXY), a measure of dollar strength against a basket of global currencies, lost around 17% in 2009, almost reaching lows seen at the height of the global recession in 2008. This coincided with the rapid growth in copper prices highlighted earlier, and has been an underlying support for the metal during the economic recovery. The sustainability of this copper rally therefore, and the potential price direction going forward, depend in a large part on what the US dollar does over the next year or so.
Although the full extent of all potential influences on the greenback, fall beyond the scope of this article, there is at least one primary issue that is likely to dominate going forward. As the US economy recovers, the potential for some inflationary pressure to come through gets more and more likely. Recent weakness in the dollar has been helped by the record low interest rates the country has had in place to help spur growth. As this no longer becomes a factor, and the low interest rates actually start to bring some risk to economic recovery, chances that the Federal Reserve will hike interest rates increase, with most analyst estimates now expecting this to come through in the second half of 2010. A rate hike will bring about some strong appreciation in the dollar against other currencies, and naturally make copper comparatively more expensive for those countries, pressuring demand and implicitly, hitting prices. The full effect and extent of any rate hike on the dollar, as well as the knock on impact to copper prices, is hard to judge, however looking at least through 2010, there is a lot of potential for a rate hike to not only remove a key support for the recent copper rally, but in fact begin to pressure prices and at least hinder, the sustainability of the rapid gains in the medium term.
Having considered some of the underlying causes for the copper price growth, both here with the currency market, and in Copper Price Analysis: Impact of Global Economic Recovery and Chinese Growth, with the effects of the economic recovery and Chinese demand growth, we must also consider to what extent market speculation has supported the metal, and therefore would represent a risk to the stability of the gains in copper prices. Using data from the US Commodity Futures Trading Commission (CFTC), we can look at the number of speculative buyers and sellers in the Comex copper market. The latest reports show that the net length of positions in the market, i.e. the number of speculative buyers minus the number of short sellers, is at some of the highest levels seen since 2006. The number of speculative long positions in the market are themselves, at the highest point since 2004, while at the same time, the number of speculative short sellers in the market are holding just above the average level.
The extent to which this is driving price gains, or is in fact a result of the copper rally, is difficult to judge. However looking at the historical pattern of speculative positions in markets which are rallying, would suggest as positions reach "overbought" levels, liquidation of long positions and a subsequent contraction in prices often comes to fruition.
This was the case, for example, in the crude oil market, when the price topped $140/bbl, while at the same time net speculative long positions in WTI Nymex futures were also at record highs. Looking at the copper market, the net long positions topped out at almost 29,000 contracts earlier this year. Compared with historical levels, the 30,000 area has been a point where paper accounts begin to look overbought, historically seeing some liquidation and a price "correction." The net position in copper, in fact, only turned "positive," that is to say there were more speculative buyers than short sellers, in the latter half of 2009, just before the copper price began the rally seen during the first quarter of this year. This shows the strong level of paper buyers in the market has undoubtedly been helping to drive copper prices higher, but it is this speculation that now offers the potential for the copper rally to at least stall in the medium term, as traders look to liquidate their positions and in doing so, pressure copper prices for the broader market.
Comparing prices and speculative positions with the underlying fundamental factors supporting copper, one could be forgiven for assuming that this divergence would inevitably lead to a fall in prices. However as John Keynes suggested, “the market can stay irrational longer than you can stay solvent,” and a simple divergence between fundamental factors and price action does not necessarily result in market selling, particularly in the short to medium term.
Looking at all these factors however it is easy to see that the recent gains in copper prices will at the very least face some obstacles in the coming year. In the longer run, any gradual and sustained economic recovery will almost inevitably result in copper prices gaining ground compared with the lows seen last year. However, the underlying shift in currency markets, as well as the extent to which speculators are driving price gains, at least brings about the possibility that prices will fall somewhat as the year progresses.
Disclosure: No positions