In last weeks segment we reviewed the price action in black gold that was a suggesting a trade-able low was in place. This week I want to turn my attention to the stalwart of the Commodities space: Copper.
Fundamental Anatomy Of Copper
The bounce in Oil and Copper is apparent over the past couple of weeks. Copper is the genuine canary in the gold mine for the commodities sector. With its broad-based industrial application, it gives a strong read upon industrial demand and growth.
The principle challenge for those calling for the Copper low is that the bottom in this metal has rarely been seen until global GDP starts to show significant improvements.
In previous extended price declines driven by financial crisis the Copper bottom was accompanied by a recovery in global GDP. Most recently the 2008/09 Financial Crisis, the sharp recovery in Copper was accompanied by a rapid increase in global GDP rising from 4-6%. In the prior cyclical rout, driven by the fallout of the Asian Financial crisis of 1999/2000 global growth rocketed printing a 4.5% from early 2000. The GDP recovery was a principal factor in both these instances and the recovery from the slump in the 1980’s. Again its was an a global GDP print of 4% or higher that drove demand and precipitated a meaningfully cyclical recovery in Copper prices.
Just last week the IMF warned that in their view conditions were indicative of the development of yet another financial crisis, driven by the slowdown witnessed in Chinese data which continues to deteriorate. This week export and import data releases disappointed expectations and continue to trend south. With China demonstrably the largest consumer of Copper, printing soft data, coupled with the largest hedge fund in the Copper space offloading assets and a soggy a 3.5% pegged for global GDP this year, it would appear premature to call the low?
The initial phase of a sustained recovery will ultimately be driven by cuts in production, there are fledgling signs that producers are starting to make moves to reduce supply. Industry reports issued this month confirm that cuts in production are materializing but not at sufficient pace to underpin a final resumption of balance in market dynamics.
The International Copper Supply Group updated it bi-annual forecast last week, noteworthy was the fact that the cumulative 566kt of surplus that was pegged for 2015-16 has now swung to a small net deficit. Crucially this small deficit wasn’t sufficient to prevent the ICSG cutting its demand outlook. The principal factor supporting the demand outlook was the reduction in supply driven by a decrease in mine supply ( Similar to the rig count scenario discussed in last weeks segment). It is believed by industry sector watchers that this supply reduction is the fundamental shift required to build a base in the sector.
Cyclical Concerns For The Patient
While the fundamental picture from a market dynamic perspective is slowly starting to point in the right direction. The historical cycles in the sector are also foreshadowing the potential for base building, the magnitude of declines are already equal to or close to historical levels.
The five-year moving average cyclical declines in Copper are currently 31% as pegged against an average cyclical drop of 36%. This figure is mapped against the last three major down cycles in Copper over the past 35 years. This would suggest that the bulk of the drop in prices is likely in or very close.
One caveat when considering this cyclical overlay, is that traditionally lows in Copper from current levels are rarely sustained. The extent of the decline would more likely require an extended base with retests before the final low is in.
The five-year average has generally required a prolonged period where price rotated around 20% below the five-year average. Currently, Copper has registered a 9 months sub 20% below the rolling five year average versus an average 15 months in prior cyclical downturns (As highlighted in chart below)
We can glean from the review above that while the low prices certainly look attractive the fundamental and cyclical factors suggest a recovery call may be somewhat premature.
Lets take a look at some charts from a technical perspective and see what they are telling us. Looking at the medium term chart on the weekly scale we have a nicely defined down channel which would appears to be guiding us towards a pivotal test of the monthly ascending trendline towards 2.00.
The weekly chart would suggest that whilst the current decline has stalled until we take out 3.00 the bears have the ball and 2.00 is the goal line in their sites.
So in this situation I would like to employ two trading approaches. I will look for a high probability short entry to target the 2.00 leaning against the trendline resistance and horizontal resistance at 3.00 targeting 2.00.
If we get some reversal patterns emerging at or around the 2.00, we will look to reverse our position to the long side, especially if this trade opportunity syncs up with a base in fundamentals and an alignment against prior cyclical bottoms.
So lets mine some more technical data and seek an entry point. For this I would like to drill down to the near term daily scale chart and review the structures in play.
- As you can see from the chart below I would look for reversal patterns towards the upper end of the channel to enter shorts targeting 2.oo leaning against 3.00.
- I will be looking for daily reversal patterns on a test of the descending trend line supports from the weekly and monthly charts to venture long on a test of 2.00. Especially if these technical conditions align with the fundamental and cyclical drivers outlined above.