Copper Prices, ETFs Still Have Plenty of Upside Potential

by: Dutch Trader

The global economic expansion scenario remains intact, which will continue to support copper prices. Based on a Morgan Stanley estimate, the annual copper consumption growth for FY2011 and FY2012 is 8.5% and 6.7%, respectively.

In addition, the floor space under construction in China is closely correlated with copper consumption (see Chart I); the recent surge of the floor space under construction should support copper consumption.

Chart I: Floor space under construction closely correlates with copper consumption

Floor space under construction closely correlates with copper consumption

Source: CEIC, Morgan Stanley Research

According to the International Copper Study Group (ICSG), an intergovernmental organization that serves to increase copper market transparency, copper supply would remain constrained, given that the industry has struggled with ageing mines, falling grades, rising operational costs, and rising capital intensity per tonne of output. From 2004 to 2010, the global copper usage has increased by 14.9%, but the production output has risen by only 4.2% (see Chart II).

Chart II: Year-on-year growth in copper consumption and mined production, 2008-2010

Source: ICSG, Morgan Stanley Research

ICSG data show a continuous decline of copper’s stock-to-consumption ratio, from 31.4 days in January 2010, to the current 27.0 days, below the long-run clearing rate of 29.6 days (See Chart III).

Chart III : Copper stock to consumption ratio, 1995-2011

Source: ICSG, Wood Mackenzie Brook Hunt, Morgan Stanley Research

Copper has still a lot of upside potential the coming years. In 2010, copper locked in a second consecutive annual gain of nearly 33 percent as demand remained elevated due to growth in China and other emerging markets and of course a weak dollar.

Global exchange inventories of copper declined by nearly 22% in 2010 and stockpiles are expected to drop further the coming years because of exhausted deposits. Furthermore, new mining and production projects are too small and insufficient to make up for the shrinking volumes and the grade of copper that is being extracted continues to deteriorate.

So the supply and demand imbalance is still intact, so if you want to play the copper shortage there are several ETF's you can choose from each with their own characteristics.

Global X Copper Miners ETF (NYSEARCA:COPX)
This ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Solactive Global Copper Miners Index. Their Top 5 Holdings are: KGHM Polska Miedz, Inmet Mining Corporation, Freeport-McMoran Copper, Grupo Mexico S.A.B. de C.V., First Quantum Minerals Ltd.

iPath Dow Jones Copper Index ETN (JJC)
The Dow Jones-UBS Copper Subindex Total ReturnService Mark is a sub-index of the Dow Jones-UBS Commodity Index Total ReturnService Mark and reflects the returns that are potentially available through an unleveraged investment in the futures contracts on physical commodities comprising the index plus the rate of interest that could be earned on cash collateral invested in specified Treasury Bills. The index includes the contract in the Dow Jones-UBS Commodity Index Total ReturnService Mark that relates to a single commodity, copper (currently the Copper High Grade futures contract traded on the COMEX).

First Trust ISE Global Copper Index Fund (NASDAQ:CU)
This fund is designed to provide a benchmark for investors interested in tracking public companies that are active in the copper mining industry based on analysis of revenue derived from the sale of copper. Top 5 Holdings include: KGMH Polska Miedz SA, Xstrata Plc, Equinox Minerals Ltd., Rio Tinto Plc (ADR) and Ivanhoe Mines Ltd.

PowerShares DB Base Metals (NYSE:DBB)
The Fund (35% copper) is based on the DBIQ Optimum Yield Industrial Metals Index Excess Return™ and is managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely used base metals – aluminum, zinc and copper (grade A). The Index is intended to reflect the performance of the industrial metals sector.

iShares MSCI Chile Index (BATS:ECH)
The iShares MSCI Chile Investable Market Index Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Chile Investable Market Index.

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