Copper to Continue its Decline

The most heavily anticipated Federal Reserve meeting in the last seven years turned out to be a non-event. No change. The ticker flashed across the bottom of the screen, “The Federal Reserve Board has left interest rates at 0. No change.” There are lots of variables factored into their decision but the end result is that they simply didn’t feel our economy was ready strong enough to withstand even the slightest of interest rate increases. Assuming they’re right, what do we make of copper’s recent rally? Clearly an expanding economy will need more copper. Apparently, the commercial traders weren’t too keen on this idea as they’ve been net sellers in each of the last four weeks. Furthermore, the Commitment of Traders report reveals a unique imbalance that bodes poorly for copper’s future prices.

160x600The copper market has grown tremendously over the last ten years. We’ve noticed this as China has become a full player in this market. Whether this is due directly to Chinese influence or is the result of middle men, the open interest numbers don’t lie. The average open interest in the copper market has grown by about 20% over the last ten years. Some of this is attributable to the commercial traders who are the copper miners and refiners in this market but, most of the growth has come from the large speculators. In fact, we’ve now seen a couple of instances where the size of the large speculator position is actually larger than the commercial trader position. We first noticed this in April of 2014 and the large speculators were dead right. Each of the three observances since April of ’14 have been dismal speculative failures. We are currently witnessing the fourth observance of this changing landscape as large speculators became more bullish than the commercial traders beginning in early July.

We believe that this market imbalance will resolve itself towards the commercial traders’ anticipated direction. We expect this to be lower as they’ve been net sellers in each of the last four weeks. Furthermore, the recent rally has pushed the copper market into overbought territory. We believe this rally is a selling opportunity and that the swing high for this move was made Thursday, September 17th on the heels of the Federal Reserve Board’s failure to raise rates. While there’s argument over whether this is inflationary in the long-term is irrelevant as our focus is on the industrial nature of copper in a weak global economy.

Commercial traders had been selling forward production ahead of the Fed's September meeting. It turns out, the commercial traders were right in their assessment of low growth and the Fed's corresponding inaction.
Commercial traders had been selling forward production ahead of the Fed’s September meeting. It turns out, the commercial traders were right in their assessment of low growth and the Fed’s corresponding inaction.

The market’s recent move towards $2.50 was based on speculative buying in anticipation of an inflationary and growing economy. The Fed’s recent decision not to raise rates matches the commercial traders’ expectations of a weak global economy. This has left the speculative longs, who’ve become increasingly bold, stuck holding the hot potato. We’re selling December copper and placing a protective stop at $2.50, the high created by the speculatively fueled failed rally. We don’t know how far the market will decline. We do know that until the commercial traders begin to believe in a global growth story, we’ll continue to look for selling opportunities in this industrial metal.

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