Copper Facing A Meltdown

 |  Includes: CPER, CUPM, FCX, JJC
by: Chuck Kowalski

Copper futures have been trading with indecision for the last three months, but things could get very decisive in the near future.

Copper futures closed Friday at $3.4275 a pound. That is nearly right in the middle of the recent trading range between $3 and $3.80. It comes as no surprise that copper has been consolidating in a tighter range, as there are many conflicting events around the world that keep traders equally opinionated on each side.

China has to be the main factor when analyzing copper prices. The slide during 2011 can be attributed to a slowdown in demand for copper out of China. Throughout the last decade, China has had an insatiable appetite for copper. Their housing industry had been on fire, along with massive infrastructure projects that use a great deal of copper. Well, you can only continue to build at such a rapid pace for so long. Now, we might be seeing the inevitable fallout.

Stories continue to trickle in about massive overbuilding in China and it might be some time before demand catches up to the supply. This is somewhat reminiscent of the U.S. not too long ago. Housing prices in China are falling and so are stock prices. Could this be the big turn in their economy? If so, demand could continue to fall for copper in the coming years.

We can’t forget about Europe either. The euro is falling like a rock and the dollar is rallying. A stronger dollar would continue putting additional pressure on copper prices. Europe could be a ticking time bomb, as there is no solution in site for their financial problems. I would have to err on the side of prolonged economic slowdown in Europe, thus decreased demand for copper would be in the cards.

The U.S. economy could be a wildcard. The economic reports have been somewhat better recently, but still leave much to be desired. There has been some recent chatter of a turnaround in housing this year, but I hardly see home construction having any meaningful gains this year. All in all, the fundamentals point to lower prices. However, we still have to take a look at some positives.

The stock market has been moving higher along with banking and housing stocks. Is this a sign of better times ahead? The market has been consolidating for some time and this could be a breakout. And we have to consider that Europe’s problems could get swept under the rug, as has been the case many times before and in the U.S as well. There is also the possibility that China could provide more stimulus to their economy or help support housing in some way. Therefore, we have the potential for extremes in either direction for copper.

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(Click to enlarge)

Looking at the technical picture, you can see copper has been trading into a tighter and tighter range. Volume has also been decreasing, which is a confirmation of the pattern. A big breakout in either direction appears imminent. The odds point to lower prices and that is the way I would lean. However, you want to wait for confirmation of a breakout or position with some sort of straddle to capitalize on a big breakout one way or another.

Deutsche Bank on Friday cut its 2012 forecast for copper by 19 percent to $3.33 a pound. That is only about 10 cents below current prices, but the forecast is not an absolute floor price. If we do get a downside breakout, the market could break to the $2.80 to $2.90 level in a short period of time.

Investors can use copper futures to trade this setup or the commodity ETF - JJC. Copper stocks like Freeport McMoran (NYSE:FCX) will likely move along with the price of copper.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.