LONDON (Reuters) - There’s been a lot of talk about inverted yield curves over the past few days.
Specifically, last week’s inversion of the two-year and 10-year U.S. Treasury notes has raised the spectre of recession, sending tremors through U.S. stock markets.
Financial market analysts are poring over their historical data for clues as to how likely and how severe a global contraction might be.
Those who follow the copper market, however, will know that “Doctor Copper” with his honorary degree in economics got there first.
London Metal Exchange (LME) three-month copper has slumped from above $6,600 per tonne in April to a current $5,800.
Global economic weakness is being led by the manufacturing sector with activity contracting or slowing just about everywhere. That includes China, the powerhouse of industrial metals demand.
Funds are now taking an ever more bearish view of copper’s prospects on the CME market.
The current “big short” is the biggest yet seen and the only surprise is that copper has not yet cracked under the weight of all this money.
It helps that copper is once again going through one of its periodic supply squeezes.
It helps a lot more that Chinese speculators don’t yet seem ready to turn as sour on copper as the CME bears.
Funds were holding a collective net short of 68,545 contracts on the CME copper contract as of Tuesday, Aug. 13.
That was down by 6,052 contracts on the previous week but the week-on-week change is insignificant relative to the overall scale of bear positioning.
Money managers’ short positions had hit a new all-time high of 118,448 contracts the previous week, eclipsing the previous record big short in June 2019.
Expressed relative to open interest, bear bets are as large as they’ve been since the global financial crisis of 2008-2009, according to analysts at Citi. (“Commodity Flows”, Aug. 19, 2019).
You can understand the money men’s logic.
Manufacturing activity is contracting in both China and the euro zone and stalling sharply in the United States.
The automotive sector, a key driver of demand for metals such as copper and aluminium, is particularly weak as a cyclical downturn is compounded by the structural challenges of a mass migration to electric vehicles.
Against such darkening prospects, a simmering U.S.-China trade war is doubly negative, the broader impact on global trade coming with a specific hit on already stuttering manufacturing supply chains.
The financial part of the copper market is betting there’s worse to come.
The industrial part of the market is torn between the darkening macro clouds and copper’s still robust micro dynamics.
It’s clear there’s no shortage of refined copper right now. LME warehouses received almost 65,000 tonnes of metal last week, although the size of the deliveries may have had more to do with storage than copper price drivers.
Further up the supply chain, however, copper supply is in trouble again.
The International Copper Study Group (ICSG) forecast in May that global mine production would be flat this year. It will struggle to meet even that low-ball assessment.
World mine production actually fell by 1% in the first four months of 2019, according to the ICSG.
Smelters are having to accept extremely low charges for converting mined concentrate into refined metal.
The 10-member China Smelters Purchase Team (CSPT) lowered its minimum treatment charges to $55 per tonne and 5.5 cents per lb for third-quarter deliveries.
That translates into an acute margin squeeze for higher-cost smelters with CSPT members starting to talk about potential production cuts.
During past periods of low copper prices, too much production was as much the problem as demand.
This time around, there is no flood of new mine supply. There’s not even a trickle.
It’s noticeable that LME positioning isn’t nearly as bearish as that on the CME.
LME broker Marex Spectron estimates the net speculative short on the LME contract was 7.5% of open interest last Wednesday, compared with peak short positioning this year of 12.3% in June.
While New York’s bearish and London’s more ambivalent, the all-important Chinese segment of the speculative spectrum doesn’t appear to have any view.
Copper seems to have fallen off the investment radar this year in China, possibly because there have been better returns to be made in “hot” markets such as iron ore and, more recently, nickel.
The Shanghai Future Exchange’s copper contract saw volumes slide by 24% in the first half of the year and they are dwindling further this month. Current market open interest of 622,710 contracts is low by Shanghai standards.
It is the lack of any bear momentum on the Shanghai market that is helping copper withstand the bear attack on the CME, according to Citi.
It’s possible that Chinese speculative money may be reluctant to short copper because it believes a new round of government stimulus is on its way. Bears may also be mindful of the supply-chain dynamics pressuring Chinese smelters.
Then again, maybe the massed ranks of Chinese speculators just haven’t been thinking much about copper at all.
It could be a problem if they do.
Looking back at the Shanghai copper contract over the 2013-2016 bear market, Citi analysts identify five occasions when Chinese investors went aggressively short copper, three times to the tune of around $4 billion. The collective bear bets increased to $7 billion and a huge $10 billion on the other two occasions.
Citi’s conclusion is that if Chinese speculators were to commit to a median-size bear attack, “we find that this would result in an $800-per tonne copper sell-off from $5,700 per tonne to $4,900.”
By which stage you wouldn’t need an inverted yield curve to tell you something was very amiss in the global economy.
Copper’s not there yet but it’s finely balanced with uncommitted Chinese players holding the key to the next major move.
Editing by Susan Fenton