A Market Primed For Movement: Managed Money Positioning And The Potential For A Copper Short Squeeze

Equities have been under pressure as interest rates continue to rise, reaching elevated levels. Assets across every segment of the market have faced downward pressure, from equities to treasuries, and from oil to both precious and industrial metals. However, a longer-term opportunity seems to be emerging within the metals space, particularly with copper.

Copper has faced pressure for a myriad of reasons. The rapid price increase following the COVID-19 pandemic was indeed extraordinary and unusual. Consequently, a pullback from the $5.00 level from a technical standpoint was not surprising. Over the past year, we've witnessed inflation strain key copper markets. Global Manufacturing PMIs contracted as consumer spending shifted from consumables to experiences.

The energy supply shock, which began as markets reopened, pushed oil and natural gas prices higher. The peak demand for natural gas for heating and cooling in August 2022 spurred the demand for both residential and commercial solar projects. Fiscal incentives from the United States and China further intensified the demand for solar, which is heavily reliant on copper for production. However, as evident from solar companies like First Solar and Enphase, solar demand has dwindled in recent quarters. This has led to a reduced demand for copper and subsequent price drops. Nevertheless, we might be nearing a trough, and underlying fundamentals hint at a potential rally that could catch money managers by surprise.

China Increasing Copper Production

Recent data reveals China ramping up its smelting and refining demand for copper, with utilization rates exceeding 94%. While China currently taps into its supply stockpiles, the market anticipates an eventual increase in import demand to replenish domestic inventories. China's post-COVID reopening has been lukewarm at best, with economic health concerns, particularly in the real estate sector. Factors like increasing bond issuances, political leadership changes, and ongoing trade tensions with the U.S. suggest a major stimulus package may be on the horizon. Although this might not directly boost U.S. equities, it could stimulate commodity demand globally.

Fiscal Policy Influencing Onshoring Projects

Rising geopolitical tensions have presented multiple supply chain management challenges, especially within the energy sector. This has prompted companies to reconsider and decentralize their geographic strategies. Recent legislation, particularly the CHIPs Act and the Inflation Reduction Act, incentivizes reshoring manufacturing operations from overseas to the U.S. to stimulate job growth and bolster national security. This trend bodes well for the long-term demand for industrial metals like copper.

Yields

The hike in yields over the past year, as the Fed grapples with inflation, directly impacts near-term cap-ex spending tied to manufacturing growth. Copper prices are inversely related to interest rate levels. However, an eventual yield downturn, more likely due to economic deceleration than a mission accomplished scenario, could significantly influence copper prices. Prolonged high rates exert continuous bearish pressure on copper prices. However, once the market senses a peak in the Fed's rate-hiking policy and foresees a reversal, industries might increase their copper orders at reduced prices in anticipation of future expansion. Once again, current fiscal policies offer a favorable environment for industrials.

Short Interest

A critical aspect when evaluating the futures market is understanding the current market positioning of major players within the commodity space. The Commitment of Traders report, provided by the CFTC, offers insights into the stances of large traders in each tradable commodity. Presently, Managed Money entities, including CTAs and other fund managers, hold substantial short positions in copper, comparable to levels seen during the lows of the COVID-19 pandemic in March 2020. While this might appear bearish in the short term, it does create potential for a "short squeeze", which could propel copper if buying activity syncs with the bullish fundamentals.

Dollar Impact

Finally, the U.S. Dollar influences nearly all physically delivered commodities. A robust dollar typically drives copper prices down and vice versa. The dollar's current strength has pressured copper as central banks employ monetary policy against inflation, and the market continues to view the dollar as a safe-haven currency. The dollar might wane as disinflation takes hold in the market. The first half of the year might pose challenges for year-over-year inflation comparisons. Nevertheless, this is another factor to monitor as a potential positive catalyst for copper prices.

In the intricate structural foundation of global economics and commodities, copper emerges as a pivotal element, often serving as a bellwether for broader economic trends. The current landscape presents a dynamic interplay of multiple forces - from global interest rate trajectories and geopolitical tensions to reshoring initiatives and currency strengths. Central to this narrative is China's decisive role in potentially triggering a new demand surge for copper. Despite the immediate pressures on copper, driven by diverse factors like energy shocks, solar demands, and the pervasive shadow of the U.S. Dollar, the underlying fundamentals suggest a dormant bullish potential. With signs pointing towards China's stimulus initiatives and the ongoing reshoring momentum in the U.S., coupled with market dynamics like elevated short interest, the stage appears set for a potential copper breakout.