Funds are starting to turn more bullish on copper

Whisper it softly, but there are the very first signs that funds are turning more friendly to Doctor Copper.

London Metal Exchange (LME) copper has been locked into a sideways trading pattern since the middle of the year with robust internal dynamics swamped by the broader, negative macro story.

There has been strong buying interest for upside calls, which confer the right to buy, for March next year

Concerns about China’s manufacturing slowdown and the Sino-U.S. trade dispute have manifest themselves in a big fund short position on the CME copper contract since June.

That big short, however, has shrunk a lot over the last couple of weeks as the prospect of some sort of trade deal becomes more credible.

London copper, meanwhile, has seen a flurry of interest in the options market with buyers looking for upside exposure next year.

This is still a tentative turnaround but it seems as if the money men are starting to look beyond the copper-negative Trump tariffs trade.

Rolling back the short

Money managers held a net short position of 17,838 contracts on the CME copper market as of the most recent Commitments of Traders Report.

One month ago, that collective short position was 62,741 contracts and three months ago it was 74,597 contracts, an all-time record in terms of bear positioning.

Both parts of the positioning equation have changed dramatically over the last couple of months.

Outright shorts have been sharply reduced from the twin peaks of 118,000 contracts in August and September to a current 79,673 contracts.

Long positions have rebuilt significantly from 39,870 contracts a month ago to 61,835, the strongest reading since April this year, when LME copper was still trading near year-to-date highs above $6,400 per tonne.

To some extent, this roll-back of the big fund short is mechanical.

Much of the CME short positioning this year has been driven by systematic funds. Heavier-weight money men have been out of the market altogether due to the continuing mixed signals generated by the industrial metals complex.

Systematic funds, defined by algo trading, are highly sensitive to technical signals, which have steadily improved as LME copper has hauled itself higher from the early October low at $5,588 to last Thursday’s three-month peak of $6,011 per tonne.

Higher prices, in other words, have in themselves encouraged short-covering, but the simultaneous build in long positions attests to greater optimism about short-term direction.

Upside options

So too does recent activity in the LME options market.

There has been strong buying interest for upside calls, which confer the right to buy, for March next year.

Most of the activity has been focused on two specific strike prices at $6,150 and $6,600. Market open interest on each stands at 3,000 lots, equivalent to 75,000 tonnes.

There are another 1,640 lots of exchange open interest sitting on the $6,500 strike price.

Friday also brought a 920-contract jump in open interest on the February $6,300-per-tonne strike.

This surge in upside buying has attracted attention on the LME “Street” and, according to Malcolm Freeman of Kingdom Futures brokerage, “the general consensus is that this is speculative buying and that possibly a fund has decided to use the options market and avoid the cost in volatility terms of simply going long of futures”.

More broadly, speculative positioning in the London copper market has turned from short at the start of October to pretty much flat in recent weeks, according to LME broker Marex Spectron.

Shanghai speculators, meanwhile, appear to be continuing to shun copper in favour of more exciting markets such as nickel.

Open interest on the Shanghai Futures Exchange copper contract has been sliding over the last couple of months and at a current 529,000 contracts is at its lowest since early May.

Phase one liftoff?

These shifts in positioning on both CME and the LME suggest the financial community is turning more positive on copper.

JPMorgan analysts, summarising their takeaways from this year’s LME Week, noted that “in our meetings we found copper to be the favorite long across base metals among financial market participants”. (“Metals Weekly”, Nov. 7, 2019).

“The general consensus is that this is speculative buying and that possibly a fund has decided to use the options market and avoid the cost in volatility terms of simply going long of futures”

No one is denying the current weak state of demand but copper’s supply-side has also been underperforming this year, with the International Copper Study Group forecasting mine production to drop by 0.5% in 2019.

Moreover, the price weakness this year has not been accompanied by any noticeable build in inventories.

Global exchange stocks of copper were 438,000 tonnes at the end of October, up just 9,000 tonnes on October 2018.

Exchange stocks may tell only part of the story but, according to JPMorgan, inventories at consumers and end-users are also low.

This means any further supply-side disruption could “exponentially heighten the physical market impact”.

Events in Chile, the largest copper-producing country, are being closely followed.

The anti-government protests haven’t yet seriously disrupted the country’s copper sector, but the question is whether this will remain the case, particularly with multiple mine labour contract renewals pending next year.

In essence, funds are starting to bet that copper’s internal supply-usage dynamics will assert themselves over the macro uncertainties that have weighed down the price this year.

This is of course predicated on a shift in expectations about the deadlocked trade talks between the United States and China.

While U.S. President Donald Trump told reporters on Friday he hasn’t “agreed to anything”, there are rising expectations that some sort of limited trade deal is becoming more plausible.

A so-called “phase one” deal would mean a partial roll-back of tariffs. It would in all likelihood represent only a truce in the bigger stand-off between the two countries but at least lift some of the fog of uncertainty playing on markets’ minds.

It’s also evidently started to get money managers thinking about how copper might fare in the absence of that uncertainty, particularly if this year’s supply woes extend into next year.

The shift in sentiment is still tentative, though, because fund managers know as well as everyone else that everything could yet change with the next presidential tweet.