If you want to understand why there’s so much short-term churn in this market, take a look at what’s going on with Mr. Copper right now.
Copper is widely regarded as a leading indicator of market sentiment about global growth. And from that perspective, the recent rally in copper prices—copper for October delivery rose to $7212 a metric ton, a four-and-a-half month high, on the London Metal Exchange this week —you might think that the markets see growth in China (which consumes about 40% of world copper production) and the United States about to jump off the charts.
From that price move, you also might think that the copper industry, which started the year with big projected surplus of supply over demand, has swung back into a supply deficit.
But in my opinion that thinking is a basic misunderstanding of where we are in the central-bank-funds-higher-asset-prices-cycle. With so many assets trading at or near historic highs, traders are scouring the landscape in search of any trade that might yield a temporary bounce. Even if the bounce isn’t likely to last for very long. That means that whenever an asset looks temporarily cheap—and commodities have underperformed for the last four years–because it has fallen out of favor with the bulk of traders, it’s susceptible to a mini-rally—even if the fundamentals are still essentially negative.
Think of the copper trade currently as the opposite of the kind of crowded trade that makes market analysts so nervous—if everyone is in a trade, where’s the money going to come from to drive up prices further? In an uncrowded trade, there’s lots of potential money potentially available to drive up the prices of unloved assets just because the trade has been so unpopular.
I think that’s what we’re seeing right now in copper and other commodities. The difficulty is that its very hard to tell when the money that has moved into this uncrowded trade will decide to move out because the trade has become relatively popular.
If you’ll remember back to the first quarter of 2014, everybody was negative on copper. Metals researcher Thomson Reuters GFMS forecast that copper would test $6,000 a metric ton in 2014. Goldman Sachs predicted a year-end price of $6,200 a metric ton.
One reason for these extremely negative forecasts was a supply/demand forecast that showed copper would be in a 100,000-ton surplus of supply over demand in 2014.
With that kind of forecast at work, copper prices fell in the first quarter of 2014 by 10% to $6,430 a ton, the lowest level since 2010
What’s changed since those negative forecasts?
The surplus story is still effect although it looks like the surplus won’t be quite as large because higher export taxes in Indonesia have cut into copper exports from that country. But higher copper prices are likely to lead Chinese copper smelters to increase production later this year after shutdowns in the first half reduced production. $6,000 or $6,200 a ton now looks too low but a sustained rally above $7,000 doesn’t seem justified on the fundamentals, according to BNP Paribas and Macquarie. Macquarie, in fact, is looking for a downturn in the second half of 2014.
That shift to the downside doesn’t look so outlandish today after China reported a drop in copper imports in June to the lowest level since April 2013.
Of course, it’s not clear how much of that drop came from a crackdown by Chinese regulators on fraudulent copper financing at the port city of Qingdao. (That fraud, of course, also inflated demand in the past.) Chinese companies were importing copper to use not in production but as collateral for loans—and then, this is where the fraud comes in, sometimes used the same copper as collateral on multiple loans.
Unless we see a evidence of a big, sustained pick up in economic growth in China, I don’t see the upward trend in copper and other commodities lasting longer than the time it takes for the market to take this trade from uncrowded to crowded.
And by then, the market may well have found another uncrowded trade to chase for a while.