By: Costas Bocelli — December 16, 2010
IT'S BEEN CONFIRMED THAT J.P. MORGAN HAS RECENTLY AMASSED MORE THAN $1 BILLION WORTH OF COPPER, ACCOUNTING FOR MORE THAN 50% OF THE ENTIRE INVENTORY HOUSED AT THE LONDON METALS EXCHANGE (LME). IS THIS A HARBINGER OF WHERE PRICES ARE HEADED IN 2011?
Copper is an industrial metal that has many functional uses, from electrical wiring to plumbing conduits. The base metal’s demand normally correlates to the strength of global economic activity.
Copper prices in 2010 are finishing near record highs above $4.00/per pound, with a 28% year to date return. For comparison, Gold so far this year has logged a 25% return, while Silver has been this year’s precious metal standout with over a 70% gain.
Going into 2011, Copper may be poised to be the best performing metal, and the reasons are very compelling ...
Growing Demand and Tight Supplies
Global economic data confirm that the recovery is gaining momentum. From developed nations like the U.S. and Britain to emerging markets like India and Brazil, industrial production is strengthening, which creates greater need for Copper.
The largest consumer of Copper is China and, despite its efforts to cool down their red hot economy, the forecast for Copper is for an increase in Chinese demand of 9% next year.
China is reluctant to raise interest rates or boost the value of their currency to curb inflation, so they have been focusing on the banking sector by raising reserve ratios. Despite these tightening measures, the lending quota for 2011 is forecasted at Rmb 7,500 billion, which is slightly higher than 2010. This infers that construction should remain fairly robust, increasing the need for Copper supply.
Based on 2011 Copper production forecasts, global supplies will lag demand as miners race to increase utilization capacity and bring new projects on line. Exploration for this metal is very tedious, and new discoveries of reserves are rare. Much of the production comes from very old existing mines with lead times that span years on new finds.
Copper Futures Predict Higher Prices
The tight supply of Copper is directly seen and confirmed in the financial markets. Near term delivery Copper is trading at a premium to delivery months farther out. This effect across the “board” is called backwardation, which is very bullish for prices as it shows that the market wants the commodity now and is willing to pay up and take delivery immediately.
The backwardation tilt is the opposite of contango, where prices for a commodity generally trend higher further out in time -- which is the more usual pricing pattern. Backwardation suggests that investors are worried about a short to intermediate term price squeeze.
The Catalyst that Could Send Copper Soaring
Copper prices are certainly pressured from organic demand outstripping supply, but what’s the added effect when you throw investors and speculators into the fray?
Well, you can get a feeding frenzy chasing momentum and parabolic returns, which sends prices through the roof.
The $1 Billion Copper purchase that cleaned out the LME’s storage warehouses by J.P. Morgan was supposedly directed by a few very important customers.
The bet obviously is that copper prices are going higher -- soon.
ETFs have been very popular trading vehicles to investors, and are great ways to invest in specialized sectors of the market. The GLD (Gold ETF) and SLV (Silver ETF) have no doubt boosted the value of the precious metals, as these ETFs hold the physical metal against the shares' value.
As more investors are attracted to the precious metals and purchase the ETFs, the fund managers need to buy more of the metal to create more shares to cover demand. All of this boosts prices -- and you can imagine the snowball effect.
On top of that, three entities (J.P. Morgan Chase, BlackRock Inc. and ETF Securities LTD.) are awaiting regulatory approval to launch Copper ETFs that are similarly backed by the physical holding of the metal.
With the tight supplies needed for actual industrial use, a significant amount of the metal may just sit in warehouses backed by ETF shares collecting dust and keeping precious needed supply off the market. Investor demand could spark Copper prices to explode.
Essentially, the big J.P. Morgan buyers are front running the market with this big play on Copper.
Below is a weekly chart on Copper Futures. Earlier this week, the metal traded at $4.20/pound intraday (a new high) ...
You can get exposure to Copper in several ways. Until the physical ETFs obtain regulatory approval, there is an Exchange Traded Note that seeks to replicate the price of futures contracts in Copper, and that symbol is JJC.
The other way to get exposure is directly through the copper miners. Here are the top four:
Southern Copper Corp. (Sym: SCCO)
Freeport-McMoran (SYM: FCX)
BHP Billiton (SYM: BHP)
Rio Tinto (Sym: RIO)
Indeed, 2011 could be the year of the red metal!