Housing Starts Just Can’t Support Copper

June 18, 2009

After hitting an eight-month high just last week, copper has been on a downward slide, and not even crazy housing numbers can stop it.
  • Housing starts jump
  • Copper bows to pressure
  • Inventory overhang


Performance of MACD and RSI Feb - June 2009


When we previously talked about copper, we mentioned the economic indicator "New Residential Construction" - aka housing starts in the media - as a critical one to watch. The report details the building permits pulled, foundations started (those are the real "housing starts") and the construction completions that occur each month. The report gives a percentage change from the previous month as well as an absolute number. While the statistics can undergo huge retroactive corrections, and have large margins of error, the report is still a solid leading economic indicator. Since 28% of copper is used in construction, it makes sense that movements here influence copper's movements.

At least, that's what's supposed to happen.

Housing starts were released on Tuesday morning, and the news was positive. I'd go so far as to say they were Little Rascals Spit-Take amazing. Housing starts rose 17.2% in the month of May - a full 10 points higher than economists expected. Taken alone, this looks like great news for copper demand. But the picture is more complicated than that.


Swimming Against The Tide

Housing starts weren't the only economic indicator released Tuesday. The Producer Price Index was released at the same time, followed by the Industrial Production report shortly after. The news outside the consumer checkbook wasn't nearly as ebullient.

First, the good news. The Producer Price Index measures changes in the price producers receive for their goods at the time of sale. It includes a wide range of producers, including mining, scrap and manufacturing. For May, the PPI increased 0.2% for finished goods, about what was expected, and a positive number. Up is good.

But then there is Industrial Production, a monthly report from the Fed that looks at everything that comes out of U.S. mines and manufacturers. Total industrial production decreased 1.1% for May, with mining output dropping 2.1% and construction supply production down 1%. While this was almost what was expected (economists expected the big number to be down 1%), there is a feeling that these numbers show we're not out of the woods yet.

Strangely, copper prices have been dropping at the same time the dollar has been weakening against the euro and Chinese yuan - a weaker dollar usually serves to support copper prices as the metal becomes "cheaper" for investors using foreign currencies. Not so this week - there is just too much pressure elsewhere in the market.

Against all of this other economic data, the good news of the housing starts didn't stand a chance, or simply aren't being believed.


Copper Supply

Last week, the news was full of the record amounts of copper China had been importing for the past four months. When the big kid on the block starts buying up all the shiny toys, the market takes notice, and last week's price increase was the result. Analysts talked about real-versus-stockpile demand, and many suggested that the metal was due for a drop. It looks like they may have called it correctly.

The inventory situation is also complex: Copper inventories on the London Metals exchange continue to drop most (likely fueled by China's buying spree), but so far we're not seeing any plans to increase production, because the price reaction hasn't been strong enough. Inventories are still far above the five-year average. And here in the U.S., inventories tracked by NYMEX have been rising for the past 30 days, which follows along with the economic data coming out of the U.S showing slowing production. Obviously, if no one is making electronics or plumbing pipes, copper inventories in the U.S. are going to rise.

Crystal Ball Anyone?

Analysts such as Judy Zhu at Standard Chartered in Shanghai are putting copper prices around $4,750 per tonne in the third quarter (down from around $5,000) and then down to $4,000 in the fourth. As quoted in this Reuters article, she states, "base metals will be in a downtrend for the second half of the year."

On a positive note - albeit a long-term one - Goldman Sachs doesn't expect the current price drops to be long lasting. It recently forecast the metal to reach $5,800 per tonne by the end of 2010 based on increased volumes in long-dated futures contracts. That hasn't shown up as a big spike in contango, however, and if you happened to have invested in iPath's DJ AIG Copper TR Sub Index ETN [JJC] at the beginning of the year, you are still in pretty good shape. Copper has been in backwardation, at least for the near-term rollovers, and that means a front-month future position has been working quite nicely.


Performance of JCC - Feb to June 2009


Note: If you're new to copper, yes, it gets quoted both by the tonne (LME) and by the pound (NYMEX), but in dollars in both cases. You can just multiply the pound price by 2,204 and it all works out.


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