Is Copper Melting?The red metal is widely regarded as a barometer of global economic health.
Despite thin investments in production in recent years, copper prices have been bullish since June this year. Anticipation of China re-opening from Covid linked restrictions and less than expected inflation prints in the US have fueled a near 15% rally in copper prices over the last two weeks.
Notwithstanding the recent bullishness in prices, this case study provides a brief macroeconomic backdrop making a case for short term headwinds even as the long-term bullishness for copper remains solid.
Real Estate in China
Against a backdrop of wider ESG recognition, de-carbonisation & EV adoption, and couple that with low investments in copper production, all this points to copper’s bullish outlook over the long term.
However, massive macro headwinds, chiefly from the troubled real estate sector in China and rising interest rates are likely to slam brakes on copper price rise in the short term. China consumes more than half of global copper production. Within China, real estate represents a lion’s share of copper usage.
Rising default rates in real estate loans, deleveraging among construction firms, and declining/slowing growth in real estate lead to anemic demand. Soft demand for copper from China is likely to send prices downwards in the near term.
Strong Dollar despite recent price retracements hurts commodity consumers
A majority of the global equity markets have plunged massively with change in the interest rate regime. Projects that used to make sense when the cost of financing was zero, now do not make commercial sense. Companies are facing shrinking profits and the outlook appears bleak for many firms across various industries with few exceptions. A resilient and strong dollar doesn’t help much either.
Commodities that are traded in USD fuels inflation in non-dollar-based economies. Firms that are already fighting slow growth are saddled with the burden of rising costs as US exports its inflation via a strong dollar. Even though USD may weaken somewhat in the coming weeks, the year-to-date gains in the USD makes it challenging for non-US firms which will likely drag copper prices down.
Geopolitical Conflicts
The lingering geo-political conflicts and the uncertainty that comes with it have put firms on their back foot. Businesses and consumers alike are posturing defensively instead of betting on growth.
Deleveraging
Markets in general are in a deleveraging mode. This is being observed across equities, bonds, housing, company balance sheets, credit market, and crypto among others. The US Fed is determined to tame inflation lower through higher rates for longer. This is likely to create an onset of recession starting with rising unemployment rate. As that sets in, we could see a decline in consumer demand which will subsequently affect commodity prices negatively.
Technical Signals
Copper prices rallied last week heading into a resistance band has not been breached since June. After a positive CPI print, prices moved above this band on positive sentiment. The RSI points to overbought as it hit 69.19 while BBW hit a 3-month high indicating a potential reversal in the uptrend. The 200-day moving average is currently at 3.9905 which could offer a resistance level in the current larger downtrend. Although the March contract saw elevated volume on the move last week, the current contract volume was consistent with normal trading activity.
Current implied volatility for March expiry ATM Copper options is 32.71% or 2.06% daily, it has been at this level for the past month. Realized 20-day volatility has been closer to 41.16% or 2.59% and stands elevated over the past 2 weeks from the low 20’s. This means that at current implied volatility levels daily, a 1-standard deviation move at the 200-day moving average could take us to 4.07.
$3.4465 is the Point of Control for the Visible Range Volume Profile since April and could offer a potential level for taking profit. Another potential level could be 3.2945 from where price has bounced over the past 3 months.
Trade Setup
Copper Futures on CME provide exposure to 25,000 pounds of copper. Copper futures expiring in March 2023 have a maintenance margin of $5,750.
Establishing a short position with an entry price of at $3.873 with a potential target at $3.4465 would result in $10,663 in profits or a return on capital of 185.4%. However, if the stop loss at $4.07 is triggered, it would lead to a loss of $4,925 or -85.65% of capital employed. Tier 2 target at 3.2945 would lead to a profit of $14,463 or 251.5% in return on capital.
Micro Copper Futures on CME, at 1/10th the size of standard copper futures, provide a more flexible, cost-effective way to express market views. Similarly, E-Mini Copper Futures on CME offer exposure to 1/2 of a standard futures contract.
CME Real-time Market Data help identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
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Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
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