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Why Copper Is Crashing

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And the debate over the metal's future.

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The red metal is reeling.

Copper fell to its lowest level in three months on Wednesday, and continued its fall on Thursday along with most commodities. The benchmark futures contract has dropped 16% since peaking for the year at $3.5440 a pound on January 7, according to Bloomberg data.

"Technically, copper tried to hold on to the 20-day moving average but it failed," says Charles Nedoss, senior market strategist with Olympus Futures. "Yesterday was really disheartening. We closed below the 100-day moving average. With the dollar strength here, I just think we have seen a lot of longs throw in the towel."

Nedoss adds, "This market feels very heavy. I see support at $2.85 and hard support at $2.75. So we are starting to get to the point where I think we will bounce."

In 2009, copper surged 139% and ended the year at $3.3275 per pound as investors bet on expectations of a global economic bounce-back, continued red-hot growth in China, and a weakening greenback.

Now, analysts and metals mavens say the concerns driving copper prices lower are multifaceted: One, there's the impact of a stronger dollar as strategists note that the buck has broken out above the 50-, 100-, and 200-day moving averages.

"Given that the dollar looks bullish now after bottoming in December, and the fact that the credit situations in Europe don't appear to be abating any time soon, the dollar could continue moving higher and that would be a negative for the copper market," says Tom Pawlicki, the precious metals and energy analyst with MF Global.

Also, Pawlicki tells Minyanville, there's increasing worry among investors about the moves made in Beijing. Specifically, China's decision to implement an exit strategy from their monetary and fiscal easing has investors spooked, as we detailed in our article, Eyeing the Bubble in China.

This is a concern that Curt Hesler, longtime editor of the Professional Timing Service newsletter, touched on recently. Hesler isn't investing in China, he told clients.

"I am not one that believes we will see the return of the American consumer or economic vibrancy in the West anytime soon, and this will stress the Chinese export industries," Hesler wrote. "If credit is tightened on top of that, the result will be more drastic than what we saw in the West when credit froze in 2008."

Investors seem to agree with this hand-wringing: The iShares FTSE/Xinhua China 25 Index Fund (FXI), an exchange-traded fund that tracks Chinese companies traded in Hong Kong, has slipped 11% in just the past four weeks.

This worry is spilling over into the copper market, says Pawlicki.

"There is concern that the Chinese, in their efforts to target growth in the housing market, will end up diminishing growth for raw materials, including copper," he says.

In addition to the metal, miners have also been nailed: Freeport-McMoran Copper & Gold (FCX), a copper, gold, and molybdenum mining company, is down nearly 20% in the past month.

Finally, Pawlicki emphasizes, inventories on the London Metal Exchange (LME) are high and rising.

"If you flip inverse copper prices against LME stocks, they tend to correlate pretty well," Pawlicki says. "But, over the last six months, they have diverged: Stocks have gone up but so have copper prices. It is now hitting the market that demand could be much weaker than it is perceived to be."

Longer term, Pawlicki remains lukewarm on copper.

"I am neutral," he says. "The market has gotten too long. There needs to be a wash out in prices right now."

Others, though, remain more bullish.

In a recent research report, Credit Suisse analysts Michael Shillaker and Liam Fitzpatrick acknowledged all this short-term uncertainty surrounding copper prices, but told clients that, in their opinion, the mid-long-term copper outlook remains robust.

Here's the math they're using: By 2011, they figure, China should structurally be consuming 7-7.5 million metric tons of copper. Should the ex-China market normalize to around 13-13.5 million metric tons, then global demand for copper should come in around 20-21 million metric tons in 2011 or 2012.

Even if the trend demand in China falls from 15% to 10% growth, the analysts say copper demand rises by around 1 million metric tons per year from 2012 onwards.

"We do not believe that there is enough new supply coming on to fulfill this demand," they told clients.

Companies that stand to benefit, they point out, include: Xstrata, Anglo American, and Antofagasta.
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No positions in stocks mentioned.
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