Copper In Correction Mode

| About: iPath DJ-UBS (JJC)
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Summary

The red metal came a long way.

Stocks reverse.

China is not the only game in town any more.

Infrastructure prospects will create a price floor.

Scale down buying below $2.50 per pound.

While the prices of most base metals rallied throughout 2016, copper was a laggard. The red metal hit rock bottom with the other metals in January when it traded down to lows of $1.9355 per pound on the active month COMEX futures contract. Copper continued to make lower highs throughout the year despite some impressive gains by its cousins in the nonferrous metals sector.

In November, the bullish action in the rest of the industrial metals sector became just too much for copper to handle and the price broke out to the upside rising above the $2.30 per pound resistance level. Stocks of copper on the London Metal Exchange began to drop in the weeks leading up to the technical break to the upside in copper so there was a fundamental basis for the move. Copper reached a high of $2.7530 per pound on November 28 but since then the price has been in correction mode moving back to the $2.50 cent level. Copper has moved a long way after a protracted bear market that commenced in 2011 at a price above $4.60 per pound. Technical resistance was a brick wall at $2.30 for a long time and now that level has become support for the red metal.

The red metal came a long way

Copper struggled throughout the first 10 months of 2016 but on November 7 it finally was able to trade at a new high for the year above $2.3160 on the active month March COMEX futures market. Source: CQG

As the daily chart of COMEX copper illustrates, after copper broke out above technical resistance the price rallied steadily reaching a high of $2.7530 on November 28.

Copper rallied for two reasons. First, the result of the Presidential election in the United States boosted the prices of all industrial commodities. Second, and more importantly, copper warehouse stockpiles at the London Metals Exchange fell from over 350,000 metric tons in October to lows of 213,325 tons on December 12. Lower inventories fueled the price appreciation and caused copper to rally to the highest price since June 2015.

Since the recent highs, copper has been in corrective mode and the same reason copper moved higher is why it moved lower.

Stocks reverse

Copper stocks reached a low on December 12 and have been heading higher since. Source: Kitco

As the chart shows, there has been a dramatic reversal in warehouse inventories at the London Metals Exchange after December 12. As of December 21, the LME reported that stockpiles of the red metal stood at 344,025 tons. The amount of copper in London has moved back to around the level it was at in October and the price turned south. Copper was trading at $2.50 on Thursday, December 22.

While copper inventories have driven copper higher and lower over the past two months, it is likely that the demand for the metal because of infrastructure building will determine the path of least resistance for the price of the red metal in the months ahead.

China is not the only game in town any more

For years, China has been the ultimate arbiter of the price of copper. Copper is one of the basic building blocks for infrastructure and for decade's Chinese demand for the red metal supported the price. Source: CQG

As the monthly chart of COMEX copper highlights, the industrial metal traded to an all-time high of $4.6495 in February 2011. Chinese demand lifted the price to the highs as requirements for construction projects peaked and the nation built stockpiles of copper for the future.

Since the 2011 highs, the Chinese economy has cooled and the demand for copper declined. Copper fell from its highs to a bottom at $1.9355 per pound in January 2016 alongside many other base metals which also reached bottoms earlier this year. As the price came down, some of those stockpiles tied to financing arrangements put additional downside pressure on the price of the metal.

However, aluminum, nickel, lead, zinc and tin all rallied since the early 2016 lows but copper lagged its nonferrous cousins perhaps because of an overhang of metal in China.

While the Chinese economy seems to have stabilized, to an extent, as we move forward into 2017 infrastructure rebuilding in the United States may become an important factor when it comes to the path of least resistance for the metal. Historically, copper has been a bellwether commodity when it comes to reflecting global economic growth or contraction. It is now looking like GDP growth in the richest nation in the world, the United States, may begin to accelerate in 2017.

Infrastructure prospects will create a price floor

The election of Donald Trump as the forty-fifth President of the United States is likely to change the economic dynamics of the U.S. economy. With both houses of Congress behind him, President-elect Trump has pledged to rebuild the nation's roads, bridges, tunnels, airports and construct a security wall along the southern border. The largest infrastructure building project in the U.S. since the 1950s will increase the demand side of the fundamental equation for metals, minerals and energy and copper is no exception.

In the wake of the U.S. election, we have seen rallies in many industrial commodities despite a stronger dollar and higher interest rates. The potential for economic growth should put a floor under the price of copper.

Scale down buying below $2.50 per pound

It is interesting that copper predicted the election result as it broke out on November 7, the day before the citizens of the United States went to the polls. Dr. Copper has a habit of providing a prognosis for global economic conditions and when all of the polls and pundits predicted that President-elect Trump would lose the election, copper broke out to the upside in a sign that the candidate who campaigned on a platform of rebuilding the nation would be victorious.

With a Republican Senate and House of Representatives behind him, it is likely that infrastructure building legislation in the U.S. will pass through the legislature early in the new administration. Meanwhile, the increase in stocks on the LME could push copper lower and a test of the price level that it broke out from at just over $2.30 per pound is possible.

With infrastructure spending on the horizon, not only will the demand for copper increase but GDP in the United States will continue to grow. Therefore, I believe that copper will remain above technical support and that any price weakness below the $2.50 level could be a scale down buying opportunity for the months to come.

If the red metal were to break the $2.30 level once again, I would reevaluate this strategy but for now, copper has broken out of the bear market trading pattern of lower highs and lower lows in place since 2011.

For those who do not trade in the futures markets, the iPath Bloomberg Copper Sub TR ETN (NYSEARCA:JJC) provides an alternative. Source: Barchart

JJC closed at the $28.65 per share level on Thursday, December 22.

The other vehicle to look at when it comes to participating in the copper market is Southern Peru Copper Corporation (NYSE:SCCO). Source: Barchart

SCCO was trading at the $32.34 per share level on December 22. As the charts of both JJC and SCCO show, both vehicles do a good job when it comes to tracking the price of the red metal.

The increase in LME stocks to pre-rally levels could mean that more selling is coming in the copper market. However, I am a scale down buyer of the red metal with a stop below $2.30 because infrastructure building in the United States is a game-changer for the copper market and all industrial commodities regardless of the strong dollar and rising interest rates.

If you do not choose to trade or invest in copper, keep an eye on this important industrial metal. Copper predicted the results of the U.S. election when most others got it dead wrong and its price path could tell us a lot about global economic conditions throughout 2017.

I have introduced a new weekly service through Seeking Alpha Marketplace. Each Wednesday I will provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.

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.