A new Indian chief was asked by the tribe whether the winter would be cold or mild. Since the young chief never learned the ways of his ancestors, he tells them to collect firewood, and then he goes off and calls the National Weather Service. “Will the winter be bad?” he asks. “Looks like it,” came back the answer. So the chief tells his people to gather more firewood. A week later, he calls the National Weather Service again. “Are you positive the winter will be very cold?” “Absolutely,” they said. The chief tells his people to gather even more firewood, and then he calls the National Weather Service and again asks, “Are you sure?” “I am telling you, it's going to be the coldest winter on record,” said the meteorologist at the weather service. “How do you know?” the chief queried. “Because the Indians are gathering firewood like crazy!” said the meteorologist.
Although I would like to take credit for this instructive narrative, it actually came from a recent issue of Readers Digest. But it goes a long way to putting the metals markets into perspective. With increasing frequency, analysts and commentators alike are expressing concern that the run-up in metal prices is a speculative bubble building up that will soon burst. Others believe we are on the verge of a correction that will bring values more in line with the underlying fundamentals. Indeed, a look at inventory levels and prices for most metals illustrate the challenges we are facing. Although inventories for most metals have been rising — with some at multi-year highs — prices have been climbing almost in lock step.
Where is the logic? We can examine each component of the sector and hear the argument in defense of high and rising prices, but at the end of the day, it isn't very different from the Indians with the firewood — it's a circular argument. For copper, it's the same story you have been hearing for months — the stimulus program in China requires significant quantities of metal that have drawn down inventories and underpinned prices. Automotive production and sales in China have risen to record highs and the outlook is for continued growth. Infrastructure development, be it high-speed railroads, electrification of rural areas, or major construction projects all need more metal. Through May, apparent consumption in China has risen 910,000 metric tonnes (MT), or 43.5 percent to 3.001 million MT from 2.091 million MT last year, resulting in a deficit of some 1.390 million MT.
However, what hasn't gotten the same attention is the significant increase of imports of refined copper that far exceed the fundamental shortfall, and again raises the question of how much metal has gone into the strategic stockpile. Also, while it's not very significant in the grand scheme of things, inventories of copper held in Shanghai warehouses have risen more than 35,000 MT since the end of July and are up almost 70,000 MT from year-end. Elsewhere in the world, demand remains weak, as global consumption excluding China is off almost one million MT, or 18 percent, through May as compared to the year-ago period. This is hardly the fundamental environment that warrants copper prices to have more than doubled over the past eight months.
Aluminum is another case in point. Inventories held in LME (London Metals Exchange) warehouses have nearly doubled since December to a record high 4.61 million MT, yet the price has risen 25 percent over the same period. The logic here is that metal held in inventory is being used for financing, so it's not available to the market, as if to say it doesn't really exist.
Lead prices and inventories have also been trending higher over the past nine months. And last month reports of lead poisoning from smelters in China have threatened to close the operations, helping to propel the price back over the $1 level. Inventories meanwhile have risen to a seven-year high. Tin and zinc stocks are also at multi-year highs, while LME inventories of nickel are at their highest level since March 1995, yet the price is up 66 percent since year-end.
The situation in the energy complex is no less puzzling. Global demand is down, inventories have been rising to the extent that storage capacity is a problem, and major new discoveries of crude oil have been announced. Last month, however, the spot price for crude oil was $74 per barrel, up $40, or 118 percent from the December low of $34 per barrel. Clearly, this is also at odds with the fundamentals and begs the question: What is driving the markets?
Sure, our economy seems to be recovering, and the global outlook is turning more positive as well. But we are still a long way off from seeing levels of demand that lend logical support to current prices. Perhaps we are simply in the midst of a technical correction to the overall decline in values that occurred last year that just has to play itself out until the last bear finally capitulates and throws in the towel. The real problem we face is that we feel compelled to look for logical reasons for the market's behavior when we know that oftentimes, none really exists.
Where do we stand now? Let's take a look at recent pricing for some key metals. Spot copper averaged $2.8106 on Comex during August, up 42.5 cents, or 17.8 percent, over $2.3855 in July. But it was down 62.6 cents, or 18.2 percent, from $3.4364 last August. The year-to-date average now stands at $2.0417, off $1.61, or 44.1 percent from $3.6502 during the first eight months of 2008. Inventories held in Comex and LME warehouses rose 17,272 MT, or 5.2 percent, to 348,220 MT, and are up 169,955 MT, or 95.3 percent, from 178,265 MT in stock last August. The monthly average copper arbitrage narrowed to a 1.43 cents Comex premium during August, in from 2.02 cents during July, and a 2.62 cents LME premium last August. The Base Metals Barometer rose 15.8 percent during August to an eleven-month high of 233.3, with all metals rising during the month and most posting double-digit percentage gains.
The technical corner. Copper has been trading within a wide range at the upper end of the chart, suggesting a heightened level of activity by speculative investors. On Friday, Aug. 14, December copper traded up to an eleven month high of $2.96, but just a few days later, on Aug. 19, the market had fallen to $2.66, off 30 cents from the previous high. On Friday, Aug. 28, December was back up, trading to a new recent high of $2.9895, as if in an effort to break through the $3 level to uncover and touch off resting buy stops. That attempt failed however, and again, just a few days later on Sept. 2, copper was back down to $2.74.
To state the obvious, this is not the fundamentals at work and serves to demonstrate the powerful influence of speculative investment flows. The market has been in overbought territory for some time now, but it's apparent that this technical aspect, among others, has taken a back seat to the sheer weight of money coming into the market. As you can see on both the daily and weekly charts, with the market having already overcome key points of resistance, the $3 level is the next target to overcome. In the event copper gets over $3, it faces a fair amount of resistance in the $3-to-$3.20 range going back to September of last year. Conversely, failure to get beyond $3 suggests a move back to $2.75, followed by an area of support at $2.60. At the risk of repetition, however, neither the fundamentals nor technical indicators are playing a major role in the market now.
John Gross is president of J.E. Gross & Co. Inc., a metals management and consultancy firm established in 1987 and publisher of The Copper Journal, an industry newsletter he created in 1989. He is no stranger to the electrical wholesaling industry, as he was vice president of strategic metals for the North American operations of BICC Cables Corp. in 1985 (now owned by General Cable). To receive a sample copy of The Copper Journal, give him a call at (401) 667-0478 or e-mail him at [email protected].