According to Bloomberg, bullish commodity wagers have risen to 16-month highs, as the Federal Reserve's commitment for a further monetary stimulus continues to drive prices higher. The biggest gainer is copper, whose holdings increased 25-fold to 17,509 contracts. Its prices are hovering near a four-month high, as the stimulus bolstered the prospects of an improvement in demand. However, whether the prices will continue their upward trajectory remains a debate. Let us first analyze the perspectives of both sides before drawing a conclusion. Later, we will recommend investors on how to play copper while hedging their positions.
No - It Can't!
The most important argument presented by analysts who are expecting this trend to reverse is the huge amount of copper stockpiles in China. According to an estimate by Standard Chartered analyst Judy Zhu, copper stacks have grown by 20% last month, since July, which has increasingly raised speculations about a drastic reduction in metal's demand in China. Consequently, these bigger inventories are meant to lead to lower prices.
Even if the stimulus leads to a pickup in economic activity, which means demand for copper will eventually improve, the high stockpiles might take a long time to get cleared, and until then, demand for the red metal is expected to remain low.
The market also remains wary about the conditions of the property market in China, which is the top user of copper, for construction. However, recent economic indicators are spelling the startup of a possible recovery.
Yes - Why Not?
Opponents of the aforementioned point of view believe that there are certain drivers in the industry that will keep Dr. Copper moving upwards. In addition to the third round of quantitative easing (QE3), according to which the Federal Reserve is going to inject $40 billion into the U.S. economy, each month, so as to improve the weak employment market, the European Central Bank (ECB) has also announced secondary market purchases to keep bond yields low to support struggling Eurozone countries. In addition, copper also received support from the weak dollar, which is currently floating near 7-month lows.
According to a recent Credit Suisse report, all three main indicators of real estate activity in China - building starts, building completions, and sales volumes - have turned upward, increasing speculation that China's construction sector has bottomed. If that is indeed the case, it could spell a possible bottoming of the basic materials sector in the near-term, which is heavily dependent on China.
We expect copper prices to somewhat drop as a result of high stockpiles, before surging later as a result of surging demand. Hence, we remain bullish on Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) due to its handsome dividend yield, cheap valuations, and balance sheet strength. Furthermore, positive news from the automotive and housing sectors is leading to an inevitable conclusion that a demand surge is likely. The following table compares FCX with copper players Newmont Mining Corp. (NYSE:NEM) and Southern Copper Corp. (NYSE:SCCO). Please read our previous article to know why FCX is our favorite bet amongst copper players.
Forward P/E (1 year)
Share price performance (%)
Source: Yahoo Finance
Long position(s) in copper equities like FCX can be hedged by taking a short position in the copper ETF, iPath Dow Jones UBS Copper Total Return Sub-Index ETN (NYSEARCA:JJC).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Qineqt's Basic Materials Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.