Copper Has Performed Well In The Face Of Adversity

Summary

• Copper has been making lower higher and lower lows since the late December high.
• The bullish pattern remains intact.
• Tariffs are bearish for industrial commodities and distort prices.
• LME stocks weighed on the price of the red metal.
• If COMEX can hold $2.875 per pound, higher highs are on the horizon.

Copper is a bellwether commodity when it comes to industrial raw materials. Since Doctor Copper tends to diagnose the overall health and well-being of the global economy, the price of the red metal is often a reflection of growth or contraction.

Copper is an essential component of infrastructure building around the world. Over past decades China has been the demand side of the equation in the copper market as the world's most populous nation continues to modernize conditions for almost 1.4 billion people.

When the Chinese economy cooled in late 2015 and early 2016 and years of double-digit economic growth came to an end, the prices of many raw materials used in construction moved to multi-year lows and copper was no exceptions. After trading at highs of over $4.60 per pound on the nearby COMEX futures contract in 2011, the price of the nonferrous metal hit bottom at $1.9355 in January 2016. After a two-year rally, copper hit its most recent peak at $3.3345 per pound on the active month May futures contract at the end of December 2017.

Copper has been making lower higher and lower lows since the late December high

Since late last year, and on a short-term basis, the price of copper has been making lower highs and lower lows.

Source: CQG

As the chart of May COMEX copper futures highlights, the red metal established a bearish trading pattern over the first three months of 2018, falling to its most recent low at $2.9375 per pound on March 26. While the path of least resistance for copper has been bearish over recent months, from a longer-term perspective, the trend remains positive, and copper has been in consolidation mode.

The bullish pattern remains intact

A more than two-year bull market continues in early Q2 on the longer-term chart dating back to 2013.

Source: CQG

Copper futures have made higher lows and higher highs dating back to the January 2016 bottom. Over more than twenty-six months, the price of the nonferrous metal has yet to violate a higher low. The most recent critical bottom for copper futures occurred during the week of September 18 when it found a low at $2.8740 per pound. In early December copper fell to a low of $2.9205, and most recently, at the end of March, the base metal found a lower bottom at $2.9375 before moving back above the $3 per pound level.

The price action in the copper futures market has kept the bull market intact, and most recently the nonferrous metal has done so under the weight of some bearish factors.

Tariffs are bearish for industrial commodities and distort prices

In March, the U.S. administration levied tariffs on steel and aluminum of 20% and 10% respectively. While President Trump issued exemptions to some nations for "national security reasons," he followed up with $60 billion in tariffs on China for unfair trade practices, dumping on the U.S. market and theft of intellectual property. The President ran on a platform of leveling the playing field when it comes to international trade and has often said that he is seeking "fairness and reciprocity" for U.S. business on global markets. The President has sought to abandon multilateral trade deals in favor of bilateral agreements negotiated on a country-to-country basis. Time will tell if the tariffs are a bluff and posturing for trade negotiations, but China swiftly retaliated with tariffs on U.S. goods giving rise to fears of the trade war in coming weeks and months. The process of negotiations will likely drag on for months, and so will the concern when comes to markets across all asset classes.

Commodities are ground zero when it comes to tariffs, and the protectionist wave has weighed on the prices of many raw materials. While not specifically a target of tariffs, copper has likely felt the pressure from other raw materials prices. Protectionism often distorts the prices of commodities as it interferes with supply and demand fundamentals.

LME stocks weighed on the price of the red metal

The dollar which has been in a downtrend since the start of 2017 has been attempting to recover and recently traded above the 90 level on the active month June dollar index futures contract. Given the inverse historical relationship between the dollar and commodities prices, a stronger dollar and the prospects of a recovery in the value of the greenback has weighed on the price of the red metal. The dollar is the world's reserve currency and the benchmark pricing mechanism for most raw materials. Therefore, a stronger dollar tends to be a bearish influence.

While the dollar has been threatening to recover, warehouse inventories on the London Metals Exchange rose to the highest level since 2014.

Source: LME/Kitco

The five-year chart that tracks LME copper inventories shows that they recently peaked at over 388,000 metric tons, the highest level since 2014.

Source: LME/Kitco

The thirty-day chart displays the swift trajectory of the stock increase which took inventories from 317,750 tons on March 26 to over 388,000 on March 29. The move to the upside was massive considering that stockpiles of copper in LME warehouses around the world stood at just over 180,000 tons in late 2017. The move resulted in almost a doubling in inventories on the world's largest copper trading exchange.

The price of copper tends to move up and down inversely with inventories. The fact that copper held its critical support level and did not violate the pattern of higher lows for over two years in an environment where warehouse stocks more than doubled is a sign of strength for the copper market.

If COMEX can hold $2.874 per pound, higher highs are on the horizon

The critical level on the downside for the red metal and the line in the sand for the bull market stands at $2.874, the September 2017 bottom on the COMEX futures continuous contract. If that bottom can hold, stocks begin to decline, and the U.S. and China can come to terms on a trade agreement that avoids a trade war and tariffs, we are likely to see a challenge of critical resistance on the upside of $3.4445 per pound, the 2014 high in the red metal.

Copper mining companies like Freeport McMoRan (FCX), BHP Billiton (BHP) and Southern Peru Copper (SCCO) are likely to move up and down with the price of the red metal over coming weeks and months. However, SCCO is likely the purest play on the price of copper given the company's lack of diversification when it comes to the production of other metals, minerals, and raw materials. Of course, the most direct route to participation in the copper market is in the futures or forwards arena on the COMEX or London Metals Exchange. ETN products also do a reasonable job replicating the price action in the copper market.

Source: Barchart

JJC is the most popular copper ETN product with net assets of over $54 million and an average trading volume of over 63,000 shares. However, Barclays will delist JJC this month and replace the ETN with JJCB which only had net assets of $9.54 million and minimal trading volume as of Friday, April 13.

Copper has held up quite well considering that the dollar has slowed its downward trajectory, the prospects of tariffs and a potential trade war with China are distorting all commodities prices, and inventories exploded to the highest level in four years. Copper could be a low-risk and high reward play on price dips if the critical support level at $2.8740 holds over coming weeks.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s 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.

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.