August 22, 2018 / 8:46 AM / a month ago

Commentary: Copper and the (very) big fund short

LONDON (Reuters) - Peace has broken out in the Chilean copper industry with two major potential labour flashpoints resolved in as many days.

FILE PHOTO: Sheets of copper cathode are pictured at Escondida, the world's biggest copper mine, in Antofagasta, northern Chile

Last Friday brought news that the major union at the Caserones copper mine had signed an 11th-hour deal to avert a walk-out. A day later came confirmation of a settlement at Escondida, the world’s largest single copper mine.

A year of expected supply turmoil from the large number of expiring labour contracts is turning into a year of unusually trouble-free production.

You might have expected the copper price to react negatively to the double news, particularly since traders have been closely tracking every twist and turn of the protracted negotiations at Escondida, fearing another protracted strike after last year’s 44-day walkout.

But London Metal Exchange (LME) three-month copper shrugged its shoulders and has over the last 24 hours punched back above $6,000 per tonne, extending a recovery from last Wednesday’s low of $5,773 to a current $6,045.

This says much about the extent to which copper has been reacting to macro-economic rather than industry-specific drivers.

The bounce from last week’s lows has been accompanied by rising hopes that the United States and China are dialling back on recent trade hostilities.

It also says much about the extent to which funds were already maxed out on the short side.

Indeed, this month’s price meltdown was preceded by the biggest collective short ever seen on the CME copper contract.

Fund positioning on CME copper: tmsnrt.rs/2nTQb95

THE (VERY) BIG SHORT

Funds were net short of the CME’s copper contract to the tune of 29,479 contracts as of the close of business last Tuesday, Aug. 14, according to figures from the Commodity Futures Trading Commission.

That was the day before the London copper price slumped by more than 4 percent to hit its lowest level since July 2017.

It’s hard to believe that the collective short position wasn’t stretched further in that ferocious sell-off through the $6,000 per tonne level.

The net positioning figures, however, mask the play-out of two distinctive trends.

Firstly, investors are still unwinding their record long position accumulated over the course of 2017.

Money managers had built collective long exposure to almost 154,000 contracts in early September, an unprecedentedly large position, eclipsing anything seen before 2016.

As of Aug. 14 that long position was much reduced at 51,561 contracts but was still extremely large by historical standards.

By way of comparison, consider the fact that fund long exposure in February 2011, when copper soared to record highs above $10,000, was just shy of 55,000 contracts.

While long positioning has been eroded by copper’s two-month price collapse from above $7,000, funds have simultaneously been building a mega outright short position.

Coming into this month it stood at 87,942 contracts, another record-breaking manifestation of investment money at work in the copper market.

There has been a slight pullback over the course of August but as of Aug. 14, it was still a massive 81,040 contracts.

And that was before the Wednesday rout, which would have seen systematic momentum funds sell into the falling price.

Graphic on CME copper volumes and open interest:

tmsnrt.rs/2nV42fr

DR COPPER IS BACK IN VOGUE

Record fund positioning on the CME copper contract, both on the long side and now on the short side, corresponds with the step-change in volumes and market open interest that took place in late 2016.

The “Trump Rally” was so called because of the reaction of copper and other industrial metals to the promise of a major infrastructure programme in the United States.

Coinciding with the price bottoming out earlier that year after five consecutive years of downward grind, it put Doctor Copper back on investors’ radar in a big way.

CME copper futures trading volumes grew by 27 percent that year, by another 26 percent last year, and are up by 45 percent so far this year.

Activity in the CME’s copper options market has mushroomed even faster. Turnover totalled 35,140 contracts last month, more than was traded in the whole of 2015.

The much-hyped infrastructure spend hasn’t survived the first two years of Donald Trump’s presidential term, but the money has stayed in the copper market.

Volumes back in November 2016 hit what was than an all-time record of 3.53 million contracts.

The record fell in June this year, when 3.63 million contracts were traded.

Prior to 2016 CME copper futures open interest had never exceeded 200,000 contracts. At the end of July it was 301,147 contracts.

MORE VOLATILITY PLEASE?

It’s noticeable that there has been no similar explosion in trading on the London Metal Exchange. Indeed, trading activity on the LME copper contract actually fell in both 2016 and 2017 before stabilizing this year.

The inference is that the new copper investor prefers the vanilla cash-settled futures structure offered by the CME over the more arcane and higher-cost LME.

Only the CME has any real insight into the identity of Doctor Copper’s new friends, but they are in all likelihood a mix of systematic funds moving further into the commodities space and Chinese money that has breached China’s currency walls.

What is certain, however, is that an unprecedented amount of speculative money is washing around the copper market and that it is capable of shifting between bull and bear positioning at super-fast speed.

The result is the sort of vicious price meltdown that has unfolded since London copper hit a four-year high of $7,348 in early June.

And this despite the fact that copper’s underlying supply-demand landscape is relatively calm right now. The International Copper Study Group estimates the global market was in modest surplus over the first five months of this year.

If, as many of Doctor Copper’s followers believe, the market is due to move into significant deficit in a year or so’s time with a resulting bull rally, just how explosive might be the price action?

The last month could be just a taste of volatility to come.

— The opinions expressed here are those of the author, a columnist for Reuters —

Editing by David Holmes

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