Copper found a bottom at $1.9355 per pound on the nearby COMEX futures contract in January 2016. The price action in the red metal which is a barometer for global economic growth then went on a run to the upside. The price of copper made higher lows and higher highs reaching a peak at $3.3220 per pound in December 2017.
For the first half of 2018, the price mostly remained above the $3.00 per pound level and in June the threat of a strike at the Escondida copper mine in Chile to within 0.65 cents of the December 2017 peak. Copper failed to make a new high when it ran out of upside steam at $3.3155, and the price of the base metal began to slide to the downside. A strong dollar, rising U.S. interest rates, and concerns over the escalating trade dispute between the United States and China weighed heavily on the price of copper and other nonferrous metals and industrial commodities. Copper declined to a low of $2.5520 on the continuous futures contract in-mid-August as the dollar index rose to a new and higher high.
Copper is the leader of the pack when it comes to the base metals that trade on the London Metals Exchange. The most liquid nonferrous metals on the LME tend to be copper, aluminum, and zinc and the Invesco DB Base Metals ETF product (DBB) reflects the price performance of the three metals.
A period of consolidation and less sensitivity to the dollar
The decline in the price of copper ended a bull market run that had been in place since the bottom at $1.9355 per pound in early 2016. On the way to the downside this summer, the price of copper fell through levels of technical support like a hot knife through butter. Perhaps the most significant level on the downside was at $2.8750, the low from the week of September 18, 2017. Since the slide, that support has become technical resistance, and copper has not mustered enough strength to test above that price. Copper entered a period of price consolidation since the mid-August low.
As the weekly chart highlights, the price of active month copper futures contracts on COMEX has traded in a range from $2.5645 to $2.8665 since the week of August 20. The low end of the range has been just 1.25 cents above the mid-August low, and the top end has remained just 0.85 cents below the level of critical resistance at $2.8750 per pound. Copper had declined from the June high by over 23% and the period of price consolidation could have been the best medicine for the copper market which fell because of action in the currency and interest rate markets as well as the state of trade relations between the U.S. and Chinese. China is the demand side of the fundamental equation for most commodities and copper is the leader of the pack. China consumes the most copper in the world as the nation continues to build infrastructure and is the most populous country on the earth.
There are at least three reasons why the period of consolidation in the copper market could lead to a break to the upside over the coming weeks and why now could be the time to position and prepare for higher prices for the red metal in 2019.
Reason one: inventories
Despite the price weakness in the copper market since the June peak at $3.3155 per pound, stockpiles on the London Metals Exchange and COMEX division of the CME have been falling. LME inventories of copper reached the highest level since 2013 in March 2018 at over 388,000 metric tons. Since then, stocks have dropped dramatically.
As the five-year chart shows, inventories of the red metal on the world's leading copper exchange have declined steadily since earlier this year and were at the lows on December 3 at only 130,175 tons, almost 258,000 tons or more than 66% below the level just nine months ago. At the same time, stockpiles in COMEX warehouses have been dropping over the past 60 days.
As the chart shows, COMEX inventories have declined from 170,000 to the 135,000-ton level, a drop of over 20.5% over the past two months.
Declining stockpiles of copper could mean that the red metal is flowing to the world's leading consumer, China. The current low level of copper in warehouses around the world, the lowest since at least 2014 on the LME, could create problems when it comes to the availability of the nonferrous metal. It is worth mentioning that stocks of many of the nonferrous metals that trade on the London Metals Exchange have also been declining. At the same time, the strong dollar, higher rates, and protectionism have weighed on the prices of the industrial metals. Less metal in warehouses is bullish from a fundamental perspective.
Reason two: trade and China
This past weekend, Presidents Trump and Xi broke bread and discussed trade in Argentina. The U.S. President told the markets that the meeting was a great success and laid the foundation for a trade deal that will follow over the coming three months. President Trump tweeted:
The U.S. and China agreed to enter a period of negotiation leading to a deal within 90 days from the start of 2019. Over that period, there will be no new tariffs or retaliation by either side. While President Trump has been highly optimistic about the prospects for a deal that avoids an escalation of the ongoing trade dispute, the silence from the Chinese has been almost deafening. While markets embraced the optimism on Monday, December 3 when they opened following the meeting in Argentina, Tuesday's price action. Was a different story as doubt and concerns caused the stock market to plunge. The DJIA lost almost 800 points in Tuesday's trading. Copper, traded to a high at $2.8580 on Monday in the aftermath of the trade news which was the highest level on the March futures contract since late September, but as the markets turned lower on Tuesday, the price of March copper on the COMEX slipped to a low at $2.75 and settled near the bottom at $2.7590 per pound on the session.
An ongoing trade dispute between the U.S. and China could send the global economy into a recession as protectionism interferes with growth. Therefore, the odds favor a trade deal between the nations as it is in the best interest of China and the United States. China's stock market and economy have suffered during the period of escalating tariffs and retaliation. After losing the majority in the House of Representatives in the mid-term elections, President Trump will soon turn his attention to reelection efforts for 2020. The last thing either President Xi and President Trump need is a recession over the coming months. A trade deal would likely provide bullish fuel for the global economy which makes it the high odds bet when it comes to policy. We witnessed the price action in the copper market when optimism took the price of the red metal to the high end of its trading range on December 3, and back down to near the midpoint of the band that has been in place since late August on Tuesday, December 4. Given the stakes, the odds of a trade agreement over the coming three months have increased after the meeting in Argentina which will favor a higher price of copper and other industrial commodities. However, the price action could become very volatile as optimism and pessimism take turns in the news cycle over the period where the two sides negotiate the framework for a final agreement and compromise on trade.
Reason three: technical resistance and the dollar
Meanwhile, the short-term price action in the copper market has been constructive since the red metal fell to its low in mid-August.
As the daily chart illustrates, copper has been making higher lows since mid-August. The short-term chart shows that price momentum and relative strength indicators are in neutral territory which reflects the consolidation range. Daily historical volatility at 18.83% is around the norm for the red metal. At the same time, the open interest metric which reflects the total number of open long and short positions in the copper futures market declined from 259,014 contracts on October 31 to its current level at 216,791 on December 4 a drop of over 16% over the period. On October 31 the price of March copper was lower at under the $2.70 per pound level, and higher price and lower open interest is not typically a technical validation of an emerging bullish trend in a futures market. However, it is likely that the metric declined as December futures rolled to March over recent weeks which reflects the frustration of those holding long and short positions who chose to liquidate rather than roll to the next active contract. The current technical position of the copper market suggests that it will continue to consolidate above technical support and below resistance. However, copper's response to the dollar is a bullish factor for the metal.
The dollar index rose to a high in mid-August which sent the price of copper to its low at $2.5520. Meanwhile, on November 12, the dollar index climbed to a higher high at 97.53, but copper only made it down to a low of $2.6625 when the greenback. Given the inverse relationship between the dollar and commodities prices, the copper market was firm in the face of a rising dollar. When a market does not move lower in the face of a traditionally bearish influence, it tends to be a sign of fundamental strength. The critical level of resistance for the COMEX copper futures market stands at $2.8750 per pound. While the news and trade sent the red metal to the upper end of its trading range, it stopped short of that level and could need a deal between the U.S. and China to ignite a rally that takes out the upside resistance and sends copper's price back to the $3 per pound level.
DBB could be the best bet
The most direct route for an investment or trading position in copper is via the futures or futures options on the LME or COMEX division of the CME. Shares of copper producing companies like FCX, GLNCY, BHP, RIO, and others offer exposure to the price of the red metal but contain additional risks such as management, labor, and policy issues in the areas of the world where they produce the metal, and beta with the overall stock market. Copper is the leader of the metals that trade on the LME, and an environment that lifts the price of copper would likely be bullish for the prices of aluminum and zinc. The Invesco DB Base Metals ETF (DBB) has exposure to all three metals. Then fund summary for DBB states:
The investment seeks to track the DBIQ Optimum Yield Industrial Metals Index Excess Return™ (DBIQ-OY Industrial Metals ER™), which is intended to reflect the base metals sector. The index Commodities consist of Aluminum, Zinc and Copper - Grade A.
The most recent top holdings of the ETF include:
Source: Yahoo Finance
The bearish price action in the base metals sector has weighed on the value of the DBB ETF since mid-April.
As the chart shows, the price of DBB declined from $19.94 on April 18 to a low at $15.42 on August 15 and was trading at $16.41 on December 4. The ETF was $1.01 per share off the low of this year and $3.53 under the high.
I will be looking to buy DBB on a scale-down basis during the rocky period of negotiations between the U.S. and China over trade. The low level of stocks, a period of consolidation in copper, and high odds of an eventual deal on trade to avoid a recessionary environment all add up to a favorable risk-reward profile for the copper market as we head into 2019.
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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.
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.