Copper Is Trying To Stage A Comeback

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Includes: BDD, BDG, BOM, BOS, CPER, CUPM, DBB, FMAT, FXZ, HEVY, IYM, JJC, JJM, JJN, NINI, PEO, RJZ, RTM, SBM, SMN, UBM, UYM, VAW, XLB
by: Andrew Hecht

Summary

The bounce is negligible so far.

China is not booming anytime soon.

The trend is still lower.

2003 and 2008 say lower.

Today's highs.

The plight of the price of copper since 2011 has been a one-way street lower. A strong dollar, the slowdown in China and global economic weakness have weighed on the price of the red metal. In 2016, the price of copper moved below $2 per pound for the first time since 2009. Although copper has declined progressively over the past five years, tepid recovery rallies have often followed new lows. That is what we may be witnessing now. Last week, copper bounced and traded above $2 once again. However, it is going to have to move a lot higher to turn this raging bear into a bull once again.

The bounce is negligible so far

The price path of copper since 2011 has been ugly for producers of the red metal. After peaking at $4.6495 per pound in early 2011, the price of copper has fallen off the edge of a cliff.

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In 2011, the price of copper fell $1.2135 per pound. In 2012, the red metal bounced and appreciated by 21.65 cents. The selling resumed in 2013, with copper shedding 25.6 cents, and in 2014, it lost 57.5 cents per pound. Last year, it lost another 69.05 cents and closed the year at $2.1350 per pound. In early 2016, the bearish trend continued, and in January, copper put in new lows at $1.9355, the lowest price since April 2009.

The bounce from that January 19 low took copper back above the $2 per pound level last week. However, it has yet to challenge the closing level of December 2015.

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Copper has had two bullish key reversal days since the lows - one on January 19, and another last week on January 26. In both cases, the price made a lower low than the previous session and closed above the previous day's highs. In both cases, the price followed through on the upside posting gains. The metal closed at $2.0670 per pound on Friday, January 29.

Given the appreciation from the lows, the technical metrics in copper have improved. On the daily chart, the slow stochastic, a momentum indicator, crossed to the upside, indicating that the short-term trend is now higher. While the momentum indicator has drifted into overbought territory on the daily chart, it has just crossed to the upside on the weekly chart and remains in oversold territory, which is another positive sign.

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Another technical indicator, the relative strength index, is in neutral territory on both the weekly and daily charts. One worrying signal for copper in the medium term is that open interest recently rose to the highest level ever - at over 200,000 contracts. The rise occurred when the metal was moving lower. Therefore, it is probable that there are shorts in the market. This could force the price higher on a short-term basis as shorts cover their risk positions, and at the same time open interest will likely fall. Rising price and falling open interest is not a bullish sign for futures markets. Therefore, it is important to monitor the level of open interest in coming sessions.

Finally, historical volatility on the monthly chart is at 18.99%, on the weekly chart it is at 19.45% and on the daily chart it is at 20.23%. This low level of historical volatility reflects the fact that the current correction has been slow and steady. The record high level of open interest tells us that a big move is likely in the near future and that historical volatility is going to move higher.

Technical indicators for copper look relatively positive at this time. The market looks like it is getting ready for a sharp corrective rally that will result from aggressive short covering, most likely above the $2.15 per pound level, which is currently short-term technical resistance. While the technical state of the market is positive, the fundamentals are not as convincing.

China is not booming anytime soon

Copper is an important bellwether commodity. The price of the metal is a reflection of the industrial health of the global economy. Copper, like other important building blocks of infrastructure such as iron ore, steel and nonferrous metals, is highly sensitive to changes in the world's economic condition. At times, the copper price is predictive, and at others, it is reactive. Whether the dog wags the tail or the tail wags the dog, the ultimate direction of the price of copper is a result of economic strength or weakness.

Over the past decade, copper has benefited from the high rate of growth in China. Recently, the Chinese economy has shifted from heavy manufacturing to consumerism. This has caused a slowdown in the country's economy on a percentage basis. The Chinese economy has grown by leaps and bounds over recent years. However, the growth rate has slowed. When it comes to China, one has to look at it this way - it is much easier to make a 10% return on $100,000 than it is to make the same return on a billion dollars. The country now faces that issue in terms of the rate of its economic growth.

In 2015, Chinese growth slowed and the domestic equity market plunged. Despite government intervention to stimulate the economy, equity prices continue to move lower, and growth continues to slow in the Asian nation. At the same time, China has stockpiled raw materials for future growth. There are huge inventories of copper metal in the country tied to financing arrangements. The metal serves as collateral against the loans. Therefore, as the price of copper has moved lower, selling some of that collateral to meet margin calls on the loans became necessary. This problem continues to weigh on the copper market, as does the economic slowdown in China. The move by the Japanese central bank last Friday further highlights the overall economic weakness in Asia.

Chinese economic weakness is only one part of the fundamental problem for copper as we move forward in 2016. Lethargic economic growth in Europe, a strong U.S. dollar and weak commodity prices weigh on the red metal. The massive sell-off in oil has lowered the production cost for copper and other commodities, which lowers the bar for producer selling.

The trend is still lower

Copper is now at a crossroads. While short-term technicals support a corrective rally, perhaps to as high as $2.50 per pound, buying is very dangerous. Longer-term fundamentals still point to a continuation of the bear market. The trend since 2011 is clearly lower. For copper to break out to the upside on the monthly chart, it would have to trade above levels between $2.50 and $3.00 per pound. Those levels are much higher than the current price and far above short-term resistance at $2.15 per pound. Anything rally that stops short of $2.50 will signal just another lower high for the red metal. The bottom line is that the trend in copper remains lower, and fundamentals, the health of the global economy and conditions in China still favor a lower copper price.

2003 and 2008 say lower

One of the most bearish factors for copper here is where it traded in 2008. While copper fell to just below $1.94 per pound this month, it fell to $1.2475, before recovering in 2008. Another important industrial commodity, crude oil, recently fell through its 2008 lows at $32.48 per barrel and moved to lows of $26.19 in January 2016, before recovering. That was the lowest level for the energy commodity since 2003. In 2003, the price of copper was at 75 cents per pound.

Not only has crude oil plunged to lows not seen in over a decade, natural gas fell to the lowest level since 1999 in December 2015. Nickel fell to 12-year lows recently, and there are other examples of raw materials that have fallen far below lows seen in 2008. The fact is that the price of copper remains far above the 2008 lows, and over recent months, the downside has been a magnet for copper. Therefore, while it has recovered from levels not seen since 2009, below $2 per pound, there is still a lot of downside potential for the nonferrous metal.

Today's highs...

The short- to medium-term potential for a rally in copper is high. The current technical state of the market is ripe for recovery. However, the first whiff of more bad economic news out of China, a sudden rise in the dollar or a protracted fall in world equity markets will erase the technicals quickly. Copper has been making lower highs and lower lows for almost five years - this is an important and firm trend.

I believe that the high level of open interest in copper will eventually move lower. Either it will decrease on a recovery rally as shorts run for cover, or it will decrease when the metal resumes its fall and those shorts take their profits. If a recovery rally occurs and open interest begins to fall, selling copper short on a scale-up basis or buying put options on futures or a product like the iPath Bloomberg Copper Sub TR ETN (NYSEARCA:JJC) could be the best way to take advantage of the next leg down in the price. For a long time, it has been a case of today's lows are tomorrow's highs in copper. We may be entering a period of technical strength and short covering in this market. Copper is attempting to stage a comeback. The long-term trend behooves us to look past those technicals and take advantage of the fundamentals that still tell us that we have not yet seen the lows and that the metal remains on life support.

As a bonus, I have prepared a video on my website, Commodix, that provides a more in-depth and detailed analysis on the copper market to illustrate the real value implications and opportunities.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.