Funds grow wary as red-hot copper hits nine-year highs

Exchange stocks are low and LME time-spreads are tightening. Copper’s micro dynamics are reinforcing the macro reflation trade that is lifting prices across the commodities spectrum.

Throw in a sprinkling of electric vehicle stardust and you can see why the likes of Goldman Sachs and Citi are doubling down on their bull calls for the copper market.

Both banks have raised their 12-month price target to $10,000 per tonne, Goldman warning that copper may be heading for a period of “scarcity pricing”.

Yet fund managers appear cautious with money manager positioning on both the London and CME contracts plateauing even as the price has surged to fresh highs.

Investors appear to be worrying about the potential for a correction after the turbo-charged rally from the March 2020 low of $4,371.

This contrast between short-term wariness and longer-term exuberance is also clear to see in the LME copper options landscape.

Fund buying loses momentum

Funds remain heavily long copper on both sides of the Atlantic but net positioning has flattened out since October, suggesting a reluctance to commit more money to the rally.

Money managers were net long of the CME copper contract to the tune of 87,671 contracts last week, according to the latest Commitments of Traders Report (COTR).

That was up from the prior week but below last October’s peak of 91,578 contracts and a good 30% off the levels seen in the 2017 bull surge.

While outright bull bets have crept up to three-year highs, the impact has been offset by a slight uptick in outright short positions.

The same loss of appetite is evident in the London market.

Money managers flipped from short to long in the second quarter of 2020 and accumulated bullish positions through December.

Since then however, positioning has fluctuated and at a current 38,635 contracts the collective long is below its mid-January peak of 43,994.

The strong build in long positions in the LME’s “other financial” category – which captures insurance, reinsurance and pension companies – has also petered out. At 33,943 contracts the net long is now some way off its August 2020 high of 43,212 contracts.

Fund buying may have been a driver of copper’s remarkable covid-19 recovery last year but the most recent leg of the rally seems to be running partly on empty, particularly with Chinese players absent over the Lunar New Year holidays.

Or as LME broker Marex Spectron put it in a Monday client note, “liquidity remains poor with gappy intraday moves the result”.

The combination of rising prices and falling liquidity is often a market warning sign that some sort of correction and consolidation phase is coming.

Options landscape

Short-term anxiety is also clear to see in the LME copper options landscape.

While options open interest in the fourth quarter of this year remains dominated by bull strategies, there is a much more balanced picture over the shorter term.

Open interest across March, April and May is fairly evenly split between call options, which confer the right to buy copper, and put options, which confer the right to sell.

Downside puts have been in growing demand as fears of a price correction rise.

“It is noticeable in the world of metals that more and more industrial clients are buying downside put option structures to protect themselves against a collapse in prices and particularly in copper and nickel,” noted LME broker Kingdom Futures in its Monday client note.

Market open interest on March, a big liquidity month for LME options, was finely balanced between 20,195 call contracts and 18,541 put contracts at the end of last week.

Open interest in April is slanted towards the upside but puts outnumber calls in May.

It’s only in the fourth quarter that bullish exuberance reasserts itself.

Market open interest for December options is heavily skewed to the upside with 16,157 lots of calls dwarfing 2,349 lots of puts as of Friday.

The cluster of open interest on the $9,000 strike – 5,552 lots of call options – is already something of a market talking point but there are another 2,851 lots open on the $10,000 strike and even 400 on the $12,000 strike.

Buy the dip?

Such options would have seemed outlandishly bullish even a couple of months ago.

But with copper now trading above $8,000 per tonne and Wall Street’s finest calling for it to hit $10,000 per tonne over a 12-month time horizon, they don’t seem so far-fetched.

The problem is that markets aren’t supposed to move in straight lines, unlike copper’s steady one-way ascent from last year’s lows.

Fund managers seem loathe to add more length at these elevated levels, while LME options open interest suggests both investors and industry are positioning themselves for a potential correction over the coming months.

Be warned, however. If it does come, it could prove short-lived with many would-be investors still playing catch-up with the copper market.

“Based on client discussions we believe there are more discretionary investors on the sidelines than participating at this stage but equally, are universally primed to buy,” according to Goldman Sachs. (“Copper: Curtailed seasonal surplus set to reinforce path towards scarcity pricing in Q2,” Jan. 27, 2021)

Citi analysts agree. “Discretionary investors have room to add, but have not been given too many opportunities given the (…) sharp rise in prices and lack of substantial pullbacks over the past year.” (“Super-cycle sunrise? Copper to $10k/t sooner rather than later”, Feb. 16, 2021)

Unlike fast-moving algorithmic black-box funds, discretionary investors take their time before committing to a market, particularly one which burnt many of them a decade ago.

Ironically, they may now need a bit of that same copper market turbulence to join the action this time around.

(Editing by David Evans)