Wednesday, March 17, 2010

Copper Is Tipping Over. It's Going To Get Worse.

¹²This Commodity Is Tipping Over. It's Going To Get Worse.

By Matt Badiali, Editor, GrowthStockWire | 17 March 2010

The price of copper has risen 106% in the last 12 months. Some analysts will tell you it's because of China's economic recovery. You need copper to manufacture just about anything from air conditioners to pipes to big-screen TVs. So the more China produces, the more copper it consumes.

But as I've been explaining for the past few weeks, I think a good part of the rise in copper prices has been fueled by speculators and hoarders. Even as prices have climbed, stockpiles of the stuff are through the roof. It's a breakdown in the typical dynamic, where prices rise when stockpiles fall because copper is being consumed.

Now, a breakdown is headed for the price of copper itself. And China is going to cause it. Let me explain: The London Metal Exchange (LME) works as a kind of broker for metal options. You can buy and sell futures contracts of metals through the exchange. That metal sits in a warehouse for the duration of your contract.

Yesterday, I spoke to a mining analyst at a top London investment bank that specializes in metals and mining. He told me 'investment capital' (what I would call speculation) is warping the historical relationship between supply and price. Usually, as supply increases, the price falls. But recently, they've been moving in lockstep.

Speculators buy futures contracts like a consumer, but never take delivery. So the metal just sits in the warehouses. The more speculative contracts, the more copper piling up in storage. Since July 2009, about $2 billion has been spent on copper no one plans to use. And copper supplies recently hit a seven-year high.

My colleague compared the current situation in the copper market to the gold market. You don't use gold to make pipes or nails, so it's valued almost purely on sentiment. If investors are scared of paper currencies, they'll bid up the price and hoard the metal.

That's what's gotten into the copper market. And without a floor of actual manufacturing demand, any bad news could send the market into a nosedive. "Any bad news" is filtering into the market right now. Rumors are circulating that China plans to raise interest rates.

Just as in the U.S., too much easy money from super-low interest rates has stoked inflation in China. And the government recently hinted it would press on the brakes by raising interest rates and forcing banks to raise reserve requirements. If the Chinese decrease their credit supply, their economy will slow and copper demand will decline. Speculators betting on higher copper prices will get killed. In fact, a few of them have already gotten spooked. And they're starting to unwind the trade.

The volume of copper in the LME warehouses peaked in late February and has dropped 4% since. The price of the red metal has moved in step with the volume, dropping about 3%. But there's been so much hoarding fever, we're sitting on potentially a year's worth of copper supply. In the past, with this much copper in storage, you'd only get about $0.65 per pound That's 80% below today's price.

But just as sentiment bid copper way above what the fundamentals dictate, it can crush the price far below fair value. A fall of 50% even 80% is possible in the next year. If you're still long copper miners, it's time to take profits and get out. For more aggressive investors, it's time to go short.

Good investing,



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