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Two Ways to Play: Copper's Recent Sell-Off

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Get to the copper!

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Copper prices were thrown in the spotlight following China's troubling export data for February.

Copper futures on the CME have declined 4.38% from Friday's closing price.

Shanghai copper futures are even uglier, having lost 9.2%. Overnight, SHFE copper futures traded limit down, hitting the maximum allowed daily decline of -5% on the largest volume day in the history of the contract. Additionally, there was speculation that the Chinese government stepped in to purchase a sizable chunk of the futures to stabilize the market.

Copper is most commonly used in electrical wiring and plumbing pipes, both of which see strong demand during economic expansions, so investors have long watched copper prices to help determine economic trends. It has even been given the moniker "Dr. Copper" for its ability to sniff out coming recessions.

So the conventional wisdom has been that copper prices could tell us where the economy and stocks are heading.

However, due to structurally low inflation in most developed economies, copper has lost its historical correlation with the S&P 500 (INDEXSP:.INX). Over the past four years, commodity prices have generally remained subdued, while stock prices have steadily risen.

Iron ore prices have also been under pressure. As of yesterday, Chinese iron ore spot prices had declined 10.4% since last Thursday before rebounding slightly today. US steel manufacturers like US Steel (NYSE:X) have also been under pressure.

Raw materials like copper and iron ore are frequently used in China as collateral for financing. MySteel Research estimates that 40% of iron ore at China's ports is part of financing deals, or otherwise used to obtain loans.

Recent moves by the Chinese government to allow certain bad loans or deals to fail have put stress on the country's financial system, including manufacturers.


From The Bull Pen

In the US, there is no easily tradable copper ETF. However, miners like Freeport-McMoRan (NYSE:FCX), Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP), and Vale S.A. (NYSE:VALE) have all suffered losses of 15% or more in the last month on increasing volume, indicating that there may be capitulation in the space.

In particular, FCX, the most actively traded of the bunch, appears to have put in a technical double bottom near $30.50-$30.60. The stock looks ready to recapture the $32.75 area.

 
From The Bear Cave

Over the past three years, copper prices have had a close correlation with Chinese equities and the Aussie dollar. Many Australian mining companies such as Rio Tinto and BHP Billiton export much of their production to China, which drives the high correlation with Australia's currency.

If copper prices are set to decline, then the Australian dollar and Chinese stocks are likely to continue falling as well.

The Australian dollar can be readily shorted through the CurrencyShares Australian Dollar ETF (NYSEARCA:FXA). The two most popular China ETFs are iShares China Large-Cap (NYSEARCA:FXI) and iShares MSCI China ETF (NYSEARCA:MCHI)

 



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Also see:

Does the Decline of Copper Mean Anything for US Stocks?

Michael Gayed: Is the Copper Crash an Opportunity or a Crisis?

Twitter: @Minyanville

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No positions in stocks mentioned.

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