The Copper Rally took a dramatic turn on May 17th as a fierce short squeeze occurred on US contracts managed by CME Group. Just two days earlier, on May 15th, CME cash copper hit a historic peak at $5.1775 per pound, or $11,414 per metric ton, driven by notable tightness in nearby time-spreads. The premium over London Metal Exchange (LME) copper contracts surged above $1,000 per ton, indicating an unprecedented gap in pricing between the Atlantic markets.
In response to the market volatility and the pressure on short positions from a surge in investment inflows into the copper market, CME had to raise margins. Sprott Asset Management from Canada recently filed a prospectus for a copper fund backed by physical reserves, underscoring the revived interest from investors in the metal. However, the influx of speculative capital raises concerns about whether the market can effectively absorb it. This week's developments suggest that Doctor Copper might face highly turbulent times ahead.
Shorts Under Pressure Amid Surge in Investment Capital
CME short sellers find themselves directly in the path of a substantial influx of investment capital. Major commodity traders like Trafigura and IXM are reportedly redirecting metal shipments to the United States to cover their positions. While these companies are significant players in the physical copper market, they are relatively small compared to the influx of funds entering the market on the long side.
Money managers shifted to a net bullish stance on CME copper back in February, and by May 7th, they had already increased their outright long positions to the highest levels seen in six years. It's likely that more momentum-based funds have joined in during the latest surge.
Investment funds' long positions on the LME copper contract reached 99,215 lots, approximately two and a half million tons, by the end of last week, marking the most bullish positioning since the LME began publishing such data in early 2018.
According to analysts at Citi, an astounding $25 billion of speculative bullish money has flooded into the two exchanges since February.
Correction Eminent
Even those bullish on copper acknowledge that the market has surged ahead of the actual physical supply chain. A correction seems inevitable, but it might have to wait until the ongoing battle between long and short positions settles. However, any price drop is likely to attract speculative buyers, especially since copper's recent record highs have garnered significant attention. The resurgence of physically-backed exchange-traded funds indicates growing investor interest in copper, driven by its narrative of constrained supply and rising demand for green energy.
In the past, attempts to launch such funds coincided with bull markets but faced challenges due to storage costs. Whether Sprott, known for managing a physical uranium fund, succeeds remains uncertain. This time, there's broader interest beyond the metals trading community, with more investment products available. The CME's micro contract, tailored for retail investors, has seen a surge in volumes, indicating increasing engagement from both professionals and individuals.
If copper is indeed in the early stages of a multi-year bull market, investment interest is likely to continue growing, potentially disrupting arbitrage between markets. This underscores the potential turbulence if too much money floods into a finite market. These views are those of the author, a columnist for Reuters.
Effects on the Chinese Market
The frenzy of global copper futures prices brought China’s copper spot market to a standstill as a lack of demand at the current price levels take effect. China, the leading consumer of copper globally, has been predominantly receiving negative feedback from buyers, with domestic copper fabricators particularly affected by a decline in new orders. A source from a copper fabricator expressed concern, stating that a price increase should ideally be driven by demand, however, copper futures prices have detached from actual demand, adversely impacting various stakeholders from fabricators to end users.
Chinese smelters have encountered difficulties this year as they face higher costs for copper concentrate and sell refined copper at discounted prices, a trend that continues. This situation is adding to the challenges for copper fabricators. The copper industry is currently influenced by speculative trading on exchanges, which disregards market fundamentals. Despite no significant demand increase or supply shortages in the spot market, the bullish outlook on exchanges, driven by projected deficits, is negatively impacting actual industry participants.
Opportunities
Recently, the disparity between supply and demand has become more evident. Despite showing a 21 percent increase for the year, China remains oversupplied, hence, copper is likely to face challenges in making further progress.
According to Liang Kaihui, an analyst at Shanghai Metals Market (SMM), the availability of scrap copper from various sources such as pots, pipes, and wires has surged following the rise in copper prices. Fabricators have been actively converting this scrap into blister, a semi-processed form of copper, and supplying it to smelters. This serves as a substitute for imported ore, which is currently in short supply.
The surplus of scrap is reflected in its discount compared to refined copper, which reached 4,615 yuan (S$860) per tonne last week, the widest margin in at least eight years according to SMM. Despite this, the smelting industry continues to expand its capacity. Individual companies prioritize defending their market share over maximizing margins as long as they remain profitable. Additionally, local governments encourage smelters to maintain metal production to meet economic growth targets and sustain employment levels.
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