Copper - could the commodity turn lower once again?

Summary:
- Some time ago we recommended shorting COPPER hinting that the commodity is overbought by speculators
- Copper price pulls back amid profit taking on higher-yielding instruments
- Was improvement in the Chinese data just a one-off?

Improvement in China

It is hard to omit the fact that we have experienced quite a major improvement in the Chinese that as of late. Manufacturing production growth of 8.5% YoY was a surprise to say the least. Of course, bigger credit played a role. However, it should be noted that not only fixed capital investment dynamics improve but even bigger improvement was spotted in terms of completed investments’ dynamics. Taking a look at the lower part of the chart below one can see that for now high copper prices seem justified.

Completed investment dynamics (white line), fixed asset investment dynamics (yellow line), manufacturing production dynamics (green line) and LME copper prices (purple line). Source: Bloomberg

Credit impulse in China

Credit action in China intensified recently. The chart below depicts 12-month change in the Chinese credit impulse. However, it should be noted that credit impulse curve has an 18-month lead over the copper price curve. The reason for this lead is the fact that the impact of the credit impulse on the real economy is lagged. Moreover, the copper price and credit impulse with lead show strong degree of correlation. Having said that, the latest bounce higher on the copper market could have been the aftermath of the increased credit action, for example, two years ago. On the other hand, it could have been triggered by the latest recovery in the Chinese credit action as well. Nevertheless, the 12-month credit impulse still remains negative.

In spite of the latest bounce higher, the Chinese 12-month credit impulse remains negative. Source: Bloomberg, XTB Research

Price and credit impulse seasonal patterns

The chart below may look complex but upon closer examination it leads to some interesting conclusions. The chart depicts price change dynamics this year, average price change dynamics for the past 5, 10 and 30 years as well as the change in credit impulse dynamics.

Lets begin with price seasonality. It can be easily spotted that this year’s price gains were much steeper than the average for the past 5 years (orange line compared to white line). Nevertheless, 2019 YTD price change seems to be more or less in line with 10-year average. Due to limited data history price change 30-year averages are not available for January and February. However, even in this case seasonal pattern points to peak at the end of April.

Another factor that should be incorporated into our analysis are credit impulse dynamics. Change in the credit impulse was positive in both January and February but experienced significant slowdown in March. Moreover, the 5-year average suggests that credit impulse should weaken from June until the end of the year. 5-year average seems to align with the 10-year seasonal patterns.

Is reversal point in copper price change dynamics looming? Source: Bloomberg

Cheap precious metals, limited increase in US yields

In our COPPER recommendation back in March we have pointed to an interesting market situation - major increase in the copper-to-gold price ratio and decline in the US yields. Gold price held firm for some time but the past dozen or so days are marked be the sell-off. Back then we have also hinted that the trade can be hedge with the short position on TNOTE. Indeed, TNOTE decline but along with it the gold price declined as well. Nevertheless, in our opinion we should modify this strategy. One option would be to use silver instead of gold. However, apart from being a precious metal, silver is also base metal. Having said that, in case global economic growth revives there is a risk that both, silver and copper, will follow higher. On the other hand, in case data continues to point towards recession, silver may appreciate against copper due to its “precious metal” status. Moreover, one should keep in mind that copper still seems to be significantly overbought compared to aluminium or other industrial metals.

Copper-to-silver price ratio is currently very high, close to extremes from September and October 2018. Moreover, we are still experiencing major divergence with the US yields. Source: Bloomberg

Copper price is pulling back as a result of profit taking, deterioration of moods as well building exchange’s inventories. Nevertheless, the commodity is trading within a range. Similar story was played last year and it eventually led to a sell-off of around 700 USD. Source: xStation5