Copper: A Tale Of Higher Lows

by: Andrew Hecht


A bottom in January 2016.

Higher lows and higher highs.

Chinese demand and inventories support the red metal.

Economic growth supports copper.

The price for liquidity could be explosive.

On October 16, copper traded to its highest level since way back in July 2014, when the red metal hit a high of $3.2595 per pound. The improving condition of the global economy and buying from China caused the latest price peak. On Tuesday, November 14, 2017, the price of December COMEX copper futures was trading at around the $3.06 per pound level.

Copper is one of the primary building blocks of infrastructure around the world, but it is also a bellwether commodity, as it often does a great job at diagnosing the health of global economic conditions. Since January 2016, the price of copper has been making higher lows and higher highs, with its most recent peak one month ago. The price action in copper has been bullish, and the nonferrous metal has not been the only industrial commodity moving to the upside over recent weeks and months. Crude oil, nonferrous and ferrous metals, and lumber have all posted gains, but it is copper’s ascent as a bellwether commodity that is a sign the global economy continues to improve.

The metal had not traded north of the $3 per pound level from late 2014 through August 2017, and now it has been above that price since early October.

A bottom in January 2016

Copper traded at its all-time high in February 2011, when the price of the red metal reached $4.6495 per pound. Along with many other industrial commodities, the copper market spent the following almost five years correcting lower.

Source: CQG

As the monthly chart highlights, copper declined to lows of $1.9355 per pound in January 2016, which was the lowest price since April 2009. Many factors contributed to its descent, but two weighed heavily on the price of the industrial commodity. First, the dollar took off to the upside in May 2014, rising from 78.93 on the dollar index futures contract to highs of over 100 in late 2015. The dollar is the reserve currency of the world and typically has an inverse relationship with commodity prices. As the world’s reserve currency, when the dollar rallies, the price of copper and other commodities in other currency terms moves higher, which encourages selling. While the dollar pushed copper lower, it was disappointing economic growth in China that caused it to plunge to its nadir in early 2016. In late 2016 and early 2017, the Chinese domestic equity market experienced a tsunami of selling, which led the S&P 500 index to move over 10% lower during the first six weeks of 2016. Copper hit its low during this period and made a significant bottom.

Higher lows and higher highs

Following the early 2016 low, copper began its slow and steady ascent that has taken it to its recent high.

Source: CQG

As the weekly chart illustrates, since the lows, copper has made a series of higher lows and higher highs on its path to over $3 per pound. The price pattern in the base metal has been almost a case study, as each move to a higher level was followed by a period of price consolidation. From January 2016 through November of the same year, copper traded in a range from the lows to highs of $2.3145 per pound. Optimism following the U.S. election caused the price of the nonferrous metal that trades on the London Metals Exchange (LME) and COMEX division of the CME to break higher, reaching a peak of $2.8230 per pound on the nearby COMEX futures contract in February 2017. A pullback to copper to a higher low at $2.47 per pound in early May, and then it was off to the races again with copper reaching $3.2595 one month ago. The latest peak price was once again followed by a correction, which is now underway. Technical support to keep the pattern of higher lows intact stands at $2.8750, the mid-September low for the red metal.

As the weekly chart shows, open interest has been rising alongside the price of the red metal. The bullish trend has encouraged trend-following traders and speculators to hop on board the bullish trend in the industrial metal. Open interest is the total number of open long and short positions in a futures market, and when it moves higher alongside price, it is typically a sign of a robust bullish trend in a futures market. Meanwhile, technical factors continue to favor the bull market in copper so long as the critical support at just under $2.90 per pound holds. Perhaps the most bullish factor for the red metal has been that the world’s most influential consumer has been a notable buyer.

Chinese demand and inventories support the red metal

In the lead-up to the Chinese Party Congress in October, China had been on a buying spree when it comes to industrial commodities. During the Congress, President Xi consolidated his power and emerged the strongest leader of the world’s most populous nation since Chairman Mao. The Chinese leader outlined his plans out to 2050, which include addressing and improving the environment by putting strict controls on pollution emissions near major population centers within the country. He pledged to increase and upgrade living standards for the middle class and to build a “world-class” military by 2050. In 2016, following the issues in the domestic equities market, President Xi introduced the “new normal,” which addressed slower economic growth.

The world had become accustomed to double-digit economic growth in China, but the GDP of the nation rose to the second highest in the world. It is harder to grow a such an astronomical rate when nominal GDP has swelled to such a greater level than in years past, so the Chinese leader stressed the need and target for a slower, but stable, economic growth rate. His initiatives in last month’s Party Congress mean that China will continue to be the demand side of the equation for most industrial commodities to meet the nation’s infrastructure building needs. Moreover, to protect the environment, smelting, and refining of metals and other commodities that emit the pollutants causing smog and other issues on major cities means that the country will cut back on domestic production of many of the commodities required for accomplishing their goals. China will continue to import metals, minerals, and other raw materials to meet the country’s needs.

One of the signs of a pickup in Chinese imports of commodities is that visible stocks have been falling. As of November 13, stocks of copper in LME warehouses stood at 258,275 metric tons, down from over 300,000 in September.

Source: LME

Over the past year, LME stocks have been heading lower, making lower highs and lower lows, which has supported the price of the red metal.

Source: LME

Over the past five years, stocks of copper held in LME warehouses have declined precipitously from over 670,000 tons to the current level. Falling stocks is a sign of increasing demand, which is the result of economic growth not only in China but around the world.

Economic growth supports copper

The Chinese economy had come a long way from late 2015 and early 2016, when the stock market caused a round of Asian contagion that weighed on equity prices around the world. At the same time, the United States economy has been improving, and the Federal Reserve at its latest meeting upgraded growth from “moderate” to “solid,” which is a big deal when it comes to Fed-speak. Short-term rates in the U.S. have been rising since liftoff in December 2015 in response to a better economic environment, and GDP growth is currently around the 3% level. In October, the Fed began shedding the legacy of quantitative easing, as it has initiated a plan to methodically trim its swollen balance sheet.

In Europe, rates remain at the 40-basis point level and quantitative easing was recently trimmed, but no plans were rolled out for ending the program yet. However, given the improving economy, it is only a matter of time before the European Central Bank follows in the footsteps of the U.S. Fed and liftoff from negative rates and the end of QE begins. Economic growth around the world is supportive for increasing demand for raw materials, and copper is a building block that tends to serve as a barometer. Higher lows in copper is a sign that conditions continue to improve.

The price for liquidity could be explosive

The 2008 financial crisis caused the world’s central banks to become economic firefighters pouring unprecedented amounts of liquidity into the system to inhibit saving and encourage borrowing and spending to stimulate economic conditions. The U.S. took the lead under Ben Bernanke and Janet Yellen, and the European Central Bank followed.

While the world’s economy has improved dramatically, there is likely going to be a price to pay for years of cheap money via historically low interest rates and quantitative easing, which amounted to a put under the bond market to keep rates as low as possible. It is possible that we will see inflationary pressures on the economy in the years ahead because of the policies implemented over the better part of a decade by the world’s monetary authorities. The price action in Dr. Copper is not only a reflection of economic growth which has spurred demand, but of inflation in the raw materials sector. Commodity prices tend to be highly sensitive barometers of inflation, and copper could be telling us that the next Fed Chief, Jerome Powell, will have his hands full dealing with the economic condition central bankers tend to dread the most.

Meanwhile, the price path of copper has been a tale of higher lows, and so long as the red metal holds its most recent bottom at just below the $2.90 per pound level, the bullish trend will remain intact. I am a scale-down buyer of the red metal during corrective periods. For those who do not have access to trading on the LME forward or COMEX futures market, the iPath DJ-UBS Copper Total Return Sub-Index ETN (JJC) vehicle does a reasonable job replicating price action in the futures market. Additionally, the fortunes of the world’s leading copper-producing companies like Freeport-McMoRan (NYSE:FCX), Southern Copper (NYSE:SCCO), Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP), Glencore (OTCPK:GLNCY), and others will see their fortunes rise and fall with the price of the red metal. Given the price trend in the industrial sector, risk-reward continues to favor buying these companies on dips.

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Disclosure: I am/we are long GLNCY.

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.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.