Is copper deserving of the thrashing?

Even after the S&P 500 index had fallen by 17% back in August, on the doorstep of “officially” ushering in a bear market, copper prices maintained the $4-per-pound level through mid-September. But when the market broke in mid-September, it broke with a fury. By the time prices found support at $3-per-pound, December copper was trading 34% below its August 1 inter-day peak of $4.55 per pound.

Chinese imports are arguably the single largest factor affecting global copper prices, so sustainability of Chinese economic growth is of foremost concern. Economic data and moves by the government on monetary policy are carefully scrutinized.

Meanwhile, the most recent data, released on September 21, suggest that after tumbling from historic highs, Chinese imports have stabilized. August imports of refined copper rose 21% from the previous month. While still 11.9% below August 2010, monthly import levels bottomed in February and have actually been trending upwards since.

For that matter, the balance of copper-specific fundamental factors are not terribly bearish. The massive selloff was triggered by fears of a double-dip recession in the US and Europe, as well as anticipation of weakness in China. In terms of impact on copper production and consumption, there has been no obvious effect – yet.

Copper output continues to trend downwards. Chilean production has been particularly weak. The large mines took some time to recover from unusually harsh winter weather in July, in addition to on-and-off labor strife. Furthermore, ore grades have deteriorated Year-over-year monthly production in June, July, and August fell by 8.5%, 18%, and 8.7% respectively. Indonesian mines have dealt with the same set of temporary and permanent production setbacks.

According to the International Copper Study Group’s (ICSG) September 20 report, the global copper market showed a 130,000-tonne deficit for its January through June study period. That was a slightly smaller deficit than the previous month’s report and much smaller than the 286,000-tonne deficit at the same time last year. However, ICSG’s forecast for 2011 calls for a 377,000-tonne deficit and a 250,000-tonne deficit for 2012. It says that not until 2013 will we see a sufficiently potent combination of production recovery and slower demand growth to bring the global market into balance.

Cumulative global exchange warehouse stocks, which include LME, COMEX, and Shanghai, stand at 650,000 tonnes and have been drifting lower. They peaked at 700,000 tonnes in April.

Recent US economic data have surprised to the upside, most notably the September nonfarm payroll report, which was better than expected, and contained a significant upwards revision of over 50,000 jobs for the August data. To be sure, bearish economists have warned that it was a temporary respite.

At best, the positive economic data represent anemic growth, and at worst, it will all be short-lived. The hopeful signs of problem-solving in Europe may indeed be nothing more than a mirage.

Nevertheless, from a trading perspective, the market may be oversold. The most recent Commitment of Trader data show that commodity funds have gone from a net-long position of 27,000 contracts in August to a net-short position of over 5,000 contracts. Sentiment readings sank to a seven-year low, last seen when the market first broke out over the $1-per-pound level. Sentiment last fell nearly as low in early-2009 when copper bottomed at $1.20 per pound bottom.

Protect profits on short positions with a $3.40 per pound stop, close only.

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