More funds are waiting to enter the market, and this week's copper short is just a prelude to the future?

Wall Street Sights

2024-05-18 11:47Posted on the official account of Shanghai Wall Street News

Copper prices surged this week to set a new record, with CME spot prices briefly approaching the $12,000 per tonne mark, and bears are under intense pressure. At the same time, more and more bulls outside the commodity circle are ready to join this copper market feast.

Spot copper prices at CME surged to a record high of $5.1775 a pound, or $11,414 a tonne, on Wednesday. Compared to the London Metal Exchange (LME) copper contract, the premium has widened to more than US$1,000 per tonne, and pricing on both sides of the Atlantic has seen an unprecedented divergence.

In order to calm the abnormal volatility in the market, CME has increased the margin requirements. This huge arbitrage could prompt a re-inflow of physical copper into the US market, but this process could take time, and the bears would have to extend their positions at a heavy cost.

This week's copper market long and short showdown caused by the turbulent waves, also attracted the attention of more bulls outside the commodity circle.

Recently, Canada's Sprott Asset Management recently filed a prospectus for a physically-backed copper ETF fund, and the surge in trading volume of CME's micro copper contract highlights investors' growing enthusiasm for copper.

Professionals expect more money to pour into such a "relatively limited" market in the future. But the question is, can the market carry such a large amount of speculative money?

This week's turmoil may signal a period of extreme instability for the copper market.

1. The dilemma of the empty side

CME short holders are facing a huge onslaught from the bulls.

Currently, commodity traders Trafigura and IXM are moving metals to the United States to close their positions. The two companies play an important role in the physical copper market, but they are still small compared to the funds that have flooded the long market.

Since February, fund managers have shifted to bullish CME copper and boosted their net long holdings to a six-year high at the close of trading on May 7. Media analysis suggests that more trend-based funds may have joined the camp in the recent rally.

According to the data, as of the end of last week, the long position of investment funds in the LME copper contract reached 99,215 lots, equivalent to nearly 2.4 million tons, which is the highest bullish position since the LME began to publish data in 2018.

Citibank analysts estimate that the two exchanges have attracted as much as $25 billion in speculative long funding since February.

2. The exchange inventory is sluggish and the physical delivery is limited

Low exchange inventories and limited physical delivery have exacerbated the dilemma of CME bears.

The data showed that CME's registered inventory fell from more than 30,000 short tons at the end of March to the current 20,445 short tons, or about 18,548 metric tons.

This compares to 103,650 tonnes in the LME's stockpile, with the time spread suggesting that more metals are available.

Despite the discount on the CME's forward curve, the benchmark price of London spot to three-month futures reached a premium of $81 a tonne at Thursday's close.

When it comes to physical delivery, the question is the type of metal available. At the end of April, half of the LME's in-transit inventory was Russian brand metals, with the second largest component being Chinese metals.

However, neither Russian nor Chinese-produced branded metals can be used in CME contracts, and in the case of Russian metals, even more so due to US government sanctions in April.

Since simple inventory arbitrage shifts don't work, this means that it may take some time to redirect metals to the US, delaying the rebalancing of CME and LME prices.

Spreads and prices at CME have eased since Wednesday, but the U.S. spot contract is still trading at a premium of around $500 a tonne on Friday morning.

3. More bulls outside the commodity circle began to enter

Even copper bulls admit that the market is ahead of the actual supply chain status quo. The market may usher in some degree of correction, but the time for the correction may not wait until the end of the current long-short showdown.

But any price pullback will not lack speculative buyers. A market that has just hit an all-time high and made headlines will only attract more attention.

As mentioned earlier, Canada's Sprott Asset Management recently filed a prospectus for a physically-backed copper ETF fund, highlighting investors' growing enthusiasm for Dr. Copper.

In the past, companies have tried to launch such products in a bull market, but either failed to launch or struggled to remain competitive due to the high cost of metal storage.

Currently, Sprott already manages a physical uranium fund. While the success of its copper ETF remains to be seen, it is largely indicative of retail investors' growing interest in the bull market narrative of constrained copper supply and growing demand for green energy.

In the industrial metals bull market of the 2000s, fund companies were relatively late entrants, and retail investors started even later. At the time, industrial metals was still a marginal market in the investment landscape, with most investments being made in the form of cross-commodity baskets.

This time, the story of the copper bull has spread far beyond the metals trading community. More bulls outside the commodity circle are starting to enter the market.

For example, CME's Micro Copper contract provides retail investors with access to the market, with a price of 2,500 pounds per contract. On its website, CME Group states:

"This flexible contract is designed for individual investors, requires less capital investment, and has lower margin and transaction fees, making it more attractive than large copper futures contracts."

In April, the average daily volume of the contract reached 12,863 lots, the highest level since the contract's launch in May 2022 and more than double the previous record, the data showed. In the first four months of the year, the cumulative volume of the contract was equivalent to an exaggerated 670,000 tonnes of copper.

If, as many analysts predicted, copper is still at the beginning of a multi-year bull market, the number of professional investors and retail participants will only increase with each new price increase.

But the question is, can the market carry such a large amount of speculative money?

This week's turmoil suggests that the copper market can become exceptionally volatile if too much money tries to pour into a limited market.

In all likelihood, the copper market will have a period of extreme instability.