Although
copper is not the largest base-metal market (aluminum is way bigger), nor the
most valuable of the primary base metals (nickel is worth several times more
per pound), it is still arguably the most important base metal. As the base
metal of choice for investors and speculators, copper’s price offers
great insights into how traders view the global economic outlook.
With
copper prices so heavily dependent on mainstream sentiment, it
shouldn’t be a surprise that copper was brutalized during last
autumn’s stock panic. That fear bubble led to the biggest and fastest
copper plunge ever witnessed! But right after the panic’s sentiment
maelstrom passed, copper started recovering. That trend continues to this
day, creating great opportunities in elite companies mining this critical
metal.
Every
long-term investor should own the world’s best copper miners, as their
stocks’ appreciation potential in the coming years is vast. And every
speculator ought to consider trading copper stocks, as they tend to mirror
and nicely amplify moves in the broader stock markets. In order to understand
why copper stocks are so compelling for all traders, you have to first
consider copper’s epic journey over this past year.
Like a
picture being worth a thousand words, there is no better way to understand
price action in its all-important context than by digesting a well-crafted
chart. To chronicle copper’s wild ride that led to today’s great
opportunities in copper stocks, I charted the last few years’ price
action below. It is amazing, something never before witnessed in
copper’s entire history.
Back in
early 2006, the young copper bull suddenly exploded higher on a 130%
year-over-year surge in Chinese copper demand. Between late February and late
May that year, copper rocketed 90.8% higher in just 12 weeks! This stunning
vertical ascent averaging 1.5% per day looked like a parabolic blowoff, an
unsustainable speculative mania.
Indeed
copper hit its $4.08 per pound all-time high then, a far cry from its
bull’s humble origins near $0.60 in November 2001. After this 574% bull
climaxing in a parabola, there had never been a better time for a copper
crash. And while copper did indeed fall sharply, and then continue correcting
until February 2007, it didn’t return to its pre-parabola levels around
$2.25. Real demand, not just speculation, was driving it.
Starting
from that early-2006 parabola and its aftermath, copper established the
strong multi-year uptrend rendered above. It spent a lot of time up near
resistance while periodically swooning to bounce off support. But despite
this characteristic volatility, over a period of years copper was inexorably
and relentlessly climbing on balance. The best directional indicator of any
prevailing long-term trend, a price’s 200-day moving average, was
moving higher in copper.
Not only
was copper’s multi-year uptrend well-defined, its 2-year pre-panic
average price ran $3.38 per pound. If a price level can be sustained for
years, there is real demand underlying it. Artificially high prices driven
purely by speculation are built on a foundation of sand and seldom last
longer than weeks or months on the outside. Global copper demand was simply
growing faster than the global mined supply.
These
high copper prices, which persisted for so long for fundamental reasons,
establish the baseline from which the stock panic’s anomalous impact
can be measured. It is critical to realize that late 2008’s copper
plummet didn’t happen after a parabolic surge to unsustainable heights.
While definitely on the high side of its multi-year range before the panic
hit, copper had done nothing technically to warrant an epic crash.
By early
July 2008, copper came within a penny of its all-time high from 25 months
earlier. Commodities in general were thriving, with oil in the $140s and the
flagship CCI commodities index hitting an all-time high. But there was no
irrational exuberance in copper. A price just approaching levels it first
achieved over 2 years earlier, and that had held again for 4 months prior to
early July 2008, is simply not extreme.
After the
biggest and fastest upleg of this entire commodities bull by far, commodities
were certainly due for a healthy correction in summer 2008. Indeed, over the
next 2 months or so copper fell 23.6% to return to its multi-year support. This
was nothing to fear, as copper had seen similar corrections and subsequent
bounces near support in both late 2006 and late 2007. The commodities and
copper corrections, in normal conditions, would have ended in early September
2008.
But as
you know, at that fateful moment in history a bond panic was morphing into
the first stock panic seen in 101 years. Many commodities, and the CCI
itself, were at their secular support lines. And as stock-market fears
ballooned to breathtaking extremes, capital fled all risky assets at a
staggering pace. Much of it flooded into the US dollar and short-term
Treasuries, driving the biggest and fastest dollar rally ever witnessed which
seriously exacerbated commodities selling.
This
panic dynamic of fleeing everything to buy dollars is exceedingly important
to understand. Last month I wrote an essay explaining its impact on gold. I
highly encourage you to read it if you haven’t, as this was the very
same culprit behind the plummeting copper price. The stock-market fear, via
the middleman of the dollar, ultimately crushed gold and the entire
commodities complex.
As a
metal heavily dependent on prevailing sentiment and consensus economic
outlook in the best of times, it shouldn’t be surprising that copper
was hit abnormally hard in the worst of times. By the time the dust from the
panic settled in late December 2008, copper had plummeted 68.6% to $1.28 per
pound! Such an epic decline in copper was unheard of.
While
there have indeed been a handful 35% to 40% retreats in copper in the last
four decades, hemorrhaging 2/3rds of its value in less than 6 months was
mind-boggling. Copper’s stunning return to October 2004 levels
didn’t make sense even at the time. In the heart of the stock panic
even before copper bottomed, we bought and recommended a new long-term
investment in one of the world’s greatest copper miners. There was
simply no way such dismal copper prices were sustainable. As of this week,
our newsletter subscribers are already up 152% on that copper-stock
investment.
Provocatively,
copper essentially bottomed the same day that the stock panic ended. The
panic was defined by fear exceeding 50 on the VXO S&P 100
implied-volatility fear gauge, which it did continuously from October 2nd to
December 18th. Copper hit $1.28 the very next day, as stock-market fear
started to abate traders returned to this metal. While it would grind
slightly lower (0.5%) to a secondary low a week later, for all intents and
purposes copper bottomed the very day the stock panic formally ended!
Since
those depths of despair, copper has indeed staged a dramatic recovery as
expected. As of late August, it was up 129.7% from its panic low! After such
a big and fast run, many analysts are concerned today’s copper prices
are unsustainable. But again context is crucial. As you can see above, copper
remains low relative to both its pre-panic uptrend and pre-panic multi-year
average price of $3.38.
Now there
is no doubt that the post-panic world will be different than the pre-panic
one. So it may indeed be years before we see $4 copper again. But just
because of a stock panic, a purely psychological event, economic activity
doesn’t cease or become permanently crippled. All over the world people
are still building and consuming, and the global population is still growing.
Global demand for copper will remain high relative to history.
I
don’t know exactly where this puts the copper price going forward, but
I bet it will be a lot closer to pre-panic levels than its panic lows. Consider
the economies of its largest consumers, China and the US. Despite all the sound and fury in this past year encompassing a stock panic, US real
GDP is only down 3.9% year-over-year. I realize housing has been hit
particularly hard, but still US copper demand can’t have plummeted too
far when our economy is still trucking along at 96% of Q2 2008’s
pre-panic levels.
And
Chinese GDP is actually growing despite the panic! In the year ending Q2 2009
that obviously straddled the stock panic, Chinese GDP actually grew by an
amazing 7.1%! Chinese copper imports this year have risen to records in some
months. Given the state of the world economy, copper demand (and hence
prices) is likely to be far closer to pre-panic levels than the panic lows
going forward.
This is
relevant to copper stocks because most of their prices are still discounting
a future copper price closer to the panic lows than pre-panic levels or even
today’s price. Thus the copper stocks, despite their sharp runs higher
since the stock panic, remain fundamentally undervalued today. Until
investors realize $3+ copper is going to be the new norm instead of the $2ish
levels they are betting on, copper stocks are cheap. Interestingly, hard
fundamental data buttresses this bullish copper-price outlook.
Copper,
and the rest of the major base metals, are unique among commodities in that
fundamental data is available daily. The London Metal Exchange coordinates a
global network of warehouses that act as a buffer between copper consumers
and copper miners, like an emergency supply. The LME publishes their total
copper stockpiles daily, which are an extremely valuable trading tool as my
business partner Scott Wright’s research has abundantly proven.
In a
nutshell, most copper mined is sold directly to factories manufacturing
copper products for consumption. It does not pass through LME warehouses. But
if a producer temporarily mines more copper than it is under contract to
provide, it can ship its excess to an LME warehouse. And if a consumer
temporarily needs more copper than it is receiving, it can buy directly from
an LME warehouse. Thus the LME warehouse stockpiles, while existing at the
margins, offer an excellent window into global copper supply-and-demand
trends.
I’m
including the following LME copper stockpiles chart in this essay because it
offers illuminating insights into the panic selloff and subsequent recovery. Despite
claims the copper bears made at the time and still to this day that
copper’s decline was fundamentally-justified, the panic selloff in
copper was largely sentiment-driven. There was no fundamental basis for the
lion’s share of copper’s panic weakness.
The LME
stockpiles were clearly the primary driver of the big intra-trend swings in
copper in its multi-year pre-panic uptrend. When stockpiles fell towards 100k
metric tons, copper rallied up to resistance. And this makes sense. A tighter
market makes copper much less resistant to any supply disruptions (like labor
strikes or government meddling at major mines). With global demand running
about 50k tonnes per day, LME stockpiles of 100k tonnes only provided a 2-day
buffer! Naturally this led to a big speculative premium in copper.
And
conversely as LME stockpiles grew, copper tended to retreat back down to
support. For years prior to the panic, LME stockpiles slowly meandered
between 100k to 200k tonnes. And copper’s inverse correlation to these
stockpiles’ behavior is quite clear. At Zeal we used this relationship
to profitably trade elite copper stocks in our subscription newsletters. Strategically,
LME stockpiles often drive copper prices.
With this
perspective in hand, consider the events from July to December 2008 when
copper plummeted. In early July when copper topped along with the entire
commodities complex, LME stockpiles indeed started building. And by early
September when copper had made a normal intra-trend correction and was
stabilizing at support, its LME stockpiles were also stabilizing near 200k
tonnes at the top of their multi-year range.
Copper
should have bounced here, and would have in normal market conditions. But
right at this critical inflection point the panic fear started bleeding into
copper and poisoning its sentiment. Copper broke below its own support near
$3.10 or so in late September. At the time LME stockpiles were still running
around 199k tonnes. As the stock panic intensified, so did the copper selling
as speculators abandoned all risky assets.
By late
October, the copper price had plummeted 35.2% in less than 4 weeks! It was a
bloodbath. Yet did the LME stockpiles justify such a decline? Not even close.
Midway through this span, they were actually dead flat at 199k tonnes, which
would have been neutral in normal circumstances. And by late October, they
were still near 206k tonnes or up just 3.5% over the short span of time where
copper lost over a third of its value!
Witnessing
such a wicked copper plunge during a span where the stock markets were
plummeting yet stockpiles were fairly flat really highlights the sentimental
nature of this metal’s panic selloff. Copper was not falling because
there was any fundamental reason for it to, but simply because traders were
scared. The fear splash-damage from the stock panic was so great that
everyone everywhere sold everything (except US dollars and Treasuries),
including the futures traders driving the short-term copper price.
Eventually
in late October when copper was already under $2, LME stockpiles did indeed
start building rapidly as you can see in this chart. So you could make the
case that copper’s decline from $2 to its panic lows (337k tonnes that
day) was fundamentally justified. But the $3 to $2 plunge leading up to that
LME build certainly was not. I would argue a contrary position, that the big
slowdown in copper demand leading to this build was also psychological and
the direct result of the bleed-over worries from the stock panic.
Remember,
in the first 19 trading days of October the flagship S&P 500 US stock
index plummeted 27.1%! Over this same span, copper plummeted 42.6% while its
LME stockpiles merely grew 7.4% to 213k tonnes. At the time, virtually
everyone was caught up in the panic psychology and assumed a new Great
Depression was dawning. While always a silly thesis (the Zeal Intelligence
published in late November refuted it), imagine the depression fears’
impact on copper-consumer psychology.
If you
owned a factory fabricating products out of copper, and you saw the
Armageddon-like implosion of the markets in October, you would have been very
worried about your future sales. This alone would have caused you to reduce
production forecasts and hence your copper orders. On top of this, with
copper prices in a freefall you would naturally want to wait before locking in
future copper orders. Why buy now when you might be able to pay 20% less a
few weeks later?
I suspect
this dynamic is why LME copper stockpiles started soaring so dramatically in
late October in the heart of the stock panic. If this was the case, if panic
psychology drove the temporary slowdown in copper demand, then the cause of
the stockpile build was largely sentimental as well. This makes the
continuing copper selloff in November look even more anomalous despite the
soaring LME stockpiles then.
The copper
price recovery supports this stock-panic-sentiment thesis. When copper
bottomed in late December, there were 337k tonnes in the LME warehouse
network. And stockpiles just continued growing from there, peaking at 548k
tonnes in late February. Nevertheless, over this post-copper-low span where
LME stockpiles rocketed by a very bearish 62.6%, copper itself climbed 19.2%
higher. The LME build was certainly a stiff headwind, but the copper prices
were so anomalously low in the panic that it didn’t matter.
Since
their late-February highs the LME stockpiles have rapidly fallen, normalizing
back towards pre-panic levels. I suspect this trend will continue on balance
in the coming year despite the recent stockpiles surge. Note that Q3 and Q4
in pre-panic years usually saw builds as well, so there is some seasonality
at play here. The key point is copper stockpiles are normalizing towards
pre-panic levels which means copper prices will too. So $3+ copper in the
coming years is far more likely than $2ish copper.
Despite
the panic’s crushing impact on copper and copper miners’ stocks,
I still believe these equities are the best way to play this secular copper
bull. They have immense profits leverage to copper prices. If a company can
mine copper at $1 per pound, and sell it at $2, they have a $1 profit. But if
copper rallies 50% to $3, the miner can still mine at $1. So its profits soar
100% to $2 per pound, leveraging copper’s own gains by 2x. And
ultimately profits drive stock prices, and copper stocks aren’t even close
to reflecting $3 copper.
At Zeal
we’ve been actively trading this copper recovery, and we’ve used
the recent strength to realize huge copper-stock gains (90%ish) in a matter
of months in both our monthly and weekly newsletters. And despite copper and
its miners getting sucked into the stock-market pullback in the coming weeks,
the stocks’ potential remains great in the months ahead. In fact,
we’ve spent the last several months painstakingly uncovering our
favorite copper miners.
Just this
week, we published a comprehensive fundamental report profiling our favorite
dozen base-metals stocks. We started with the universe of all the
publicly-traded base-metals companies in the US and Canada, and gradually researched each to whittle down the big list to our favorites. These
are the elite companies we feel have the best odds of thriving in the coming
years due to their stellar fundamentals. These are the stocks we are trading
ourselves in our acclaimed newsletters. (Subscribe today for world-class
research and trades!)
Of our
dozen favorite base-metals stocks, half produce copper today and another two
are developing high-potential copper projects. While most of these companies
mine other metals as well, there are some fantastic primary copper stocks
profiled in our fascinating new report. While it took us hundreds of hours to
research and write, we are selling this entire new 34-page report for just
$95 ($75 for Zeal subscribers). Buy your report today and prepare to ride the
copper recovery and ongoing bull!
The
bottom line is the stock panic sucked in copper prices too. Despite its
favorable fundamentals, copper couldn’t withstand the fear maelstrom. The
collateral damage was unbelievable, as the unrelated stock panic drove
copper’s biggest and fastest losses ever witnessed by far. Of course
this was all an unsustainable anomaly like everything else in the panic, an
extreme condition that couldn’t persist without epic fear.
So once
the stock panic ended and fear started abating, copper immediately started
recovering. Despite its big gains since its panic lows, it remains well under
its pre-panic uptrend. Given its fundamentals, this recovery should continue.
And since most copper stocks’ prices are discounting copper closer to
the panic lows than today’s levels, great opportunities exist in these
miners. Eventually
they’ll reflect $3+ copper.
Adam Hamilton, CPA
Zealllc.com
September 25, 2009
Also
by Adam Hamilton
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