By Andy Home
LONDON, Jan 14 (Reuters) – Copper finds itself in a perfect bear storm.
On the London Metal Exchange (LME) benchmark three-month metal imploded this morning, touching a low point of
$5,353.25 per tonne in early trading. That’s a level not seen since 2009, the year of global financial crisis.
As ever with such violent market moves, momentum is currently king, feeding off itself as black-box funds obey the
laws of their algorithms and options players obey the laws of their delta-hedging programmes.
Technicals rule and fundamentals are pushed to one side.
But copper’s fundamentals laid the backdrop for this bear assault. This market has been trending steadily lower since
August of last year, fixated on a building wall of supply and a resulting shift to surplus.
And fundamentals may yet come back to bite the bears. That long-heralded surplus remains conspicuous by its absence,
particularly on the LME itself.
There lurks a dominant long position holder on the LME, controlling more than half of all available stocks and exerting
a vice-like grip over the front part of the LME curve.
This player has been there for many months now as has the tension between falling prices and tight LME spreads. That
tension is now becoming acute.
Who will blink first? Rampant bears or lurking bull?
TECHNICAL BEARS
This week’s price implosion marks the culmination of a long-building bear trend in the LME copper market.
Copper was already the worst performer of the core LME industrial metals last year, the gradual grind lower picking up
downside momentum in the first days of January.
The bear attack overwhelmed the $6,230 level on the first day of the new year. That had marked the low point of 2014.
A longer-standing chart marker at $6,000, a support level dating back to 2010, was breached on Monday and broken Tuesday.
Technical players of all shapes and sizes have rushed through the gap, chasing the downside momentum into the chart
void below.
Joining them will likely have been option market-makers looking to hedge their exposure to the put options that have
accumulated at strikes below $6,000.
The table below shows market open interest on copper put options, which confer on the buyer the right to sell at a fixed
price and month. What is visible, over 715,000 tonnes over the next five months, may be matched by what is not visible in the
over-the-counter options market.
The sellers of those options will have had to “delta-hedge” their exposure by selling futures, albeit at differing ratios
depending on the options’ expiry.
Such technical dynamics, attacking funds and defensive options players, go a long way to explaining the violence of the
current price action.
BEAR FUNDAMENTALS
But copper, remember, had already been heading lower for many weeks prior to today’s cataclysm.
And it had been doing so under the weight of a consensus narrative that supply was building to the point that visible
surplus would soon starting washing into exchange warehouses.
In October the International Copper Study Group forecast that after five consecutive years of supply deficit, the global
refined copper market would record a 390,000-tonne surplus this year.
Actually, most analysts had expected that surplus to arrive last year but in the event it just didn’t materialise.
This year, though, the bears argue, was always going to be the year that supply would finally catch up and overtake demand
thanks to a wave of mine investment launched in those heady days when copper was punching out new all-time highs up above $10,000.
That existing bearish supply-side prognosis has in the last few days been reinforced by a rapidly deteriorating view of
likely demand thanks to the oil price rout, the looming spectre of deflation in Europe and this week’s downgrade of global
growth prospects by the World Bank.
Just to spice up this heady bear cocktail a bit more has been the strength of the U.S. dollar, a major headwind for any
dollar-denominated commodity such as copper.
A perfect bear storm for copper then. Too much supply. Weaker demand. And a downwards spiral of technical selling.
SURPLUS TOMORROW?
Or is it?
The irony is that analysts were already starting to whittle away at that expected numerical supply surplus this year before
this week’s dramatic turn of events.
Major producers such as Rio Tinto and BHP Billiton have warned of lower output at key mines such as
Bingham Canyon and Escondida respectively.
Barrick Gold Corp has threatened to suspend its Lumwana copper mine in Zambia in response to a proposed hike in
royalty rates. The Zambian government is so far unmoved.
New mines, meanwhile, will experience the usual teething problems associated with any start-up and several of them will
produce raw materials containing high levels of impurities such as arsenic. Such concentrates require blending, injecting
another potential bottleneck into the supply chain.
All of which conforms with copper’s historical propensity to underperform on the supply side even during periods of high
prices.
With prices having fallen so severely so quickly, there may well be more market-driven constraints ahead.
Scrap supply will certainly dwindle in the immediate future.
It always does when the copper price collapses since few scrap players hedge their price exposure. The natural hedge in the
secondary sector of the market is simply not to sell material bought at higher prices until those prices recover.
And then there is China. The country’s stockpile manager, the State Reserves Bureau (SRB), has already been highly active
over the last 12 months, capitalising on lower prices to soak up metal. The further prices fall, the greater its likely appetite.
These are copper’s fundamental stabilisers and they will kick in ever harder on further price weakness.
Meanwhile, the expected supply surplus, the starting point of copper’s fall from grace, may not be the given that many have
assumed.
THE LAST BULL IN TOWN
Certainly, tangible evidence of surplus remain elusive right now.
LME stocks have been edging up, but the 25,300-tonne net increase since the start of December is highly modest for what
is seasonally a low point in first-stage consumption due to year-end holidays in much of the developed world.
Available tonnage on the LME, excluding that earmarked for physical drawdown, remains extremely low by any historical
yardstick at 170,975 tonnes.
And crucially, more than half of it is held by one player.
The LME’s dominant position reports offer only a rear-view mirror. Today’s report, for example, shows the state
of play as of the close of business Monday.
Maybe the long has capitulated in the interim. The way spreads have been trading today, though, suggests not.
“Tom-next” is the shortest-dated spread in the LME’s arcane prompt date system. Today it denotes the cost of
rolling a position from Thursday to Friday and at one stage this morning it traded out to a $24 per tonne backwardation.
The full cash-to-three-months period ended Tuesday valued at a $80 backwardation.
Such backwardation levels denote a market that is both positionally and structurally tight.
It’s the nature of the LME market that no-one leaves the table without adjusting their position across the spreads. As
long as the bull holds its nerves, today’s short-sellers may pay a heavy price.
It just comes down to who has called this market right.
The massed ranks of technical bears or the last bull in town? – REUTERS
