Will Copper Shine Brighter than Gold?Intricate dance between gold and copper prices is a tale beyond mere metals. It reflects global economic sentiments, industrial demand, geopolitical angst, and investment trends.
Gazing into the crystal ball to decipher the future of the gold to copper ratio, a fascinating narrative unfolds, particularly highlighting copper's brighter prospects.
Copper is displaying record futures premium unseen since 1994 fueled by supply side concerns. Beacon of positive economic data from China, is helping Copper shine brighter than Gold.
This paper delves into the forces propelling copper and illustrates how portfolio managers can use the gold-to-copper ratio to gain risk reduced exposure to copper’s ascent.
COPPER SUPPLY IS FACING PLENTLY OF HEADWINDS
Mined copper and Refined copper are facing potential supply disruptions.
Copper miners have benefited from the growth in supply over the past year. Australian mining giants reported higher annual copper production (BHP up 7% and Rio Tinto up 3%). Both benefited from a higher realized price.
Copper mining costs for Australian miners were higher due to outages. While copper operations have done well, other commodities have not. Iron Ore, Aluminum, Platinum Group Metals, and Nickel prices are performing poorly. This has negatively impacted performance of mining majors. BHP profit was flat while Rio Tinto was down 9%.
It is likely that miners will start scaling down production to boost profitability. Some have already started. For instance, Anglo American announced that it would lower its copper production guidance by 20% to 730k-790k tonnes.
Mine outages are another source of concern. Macquarie Bank highlighted that disruptions remain elevated resulting in supply deficit of 700k tonnes in 2024.
Copper shortage risks exacerbating the ongoing raw material shortage at refiners. Chinese copper smelters announced a rare joint production cut last month due to shortage of ore. Consequently, Chinese copper spot treatment charges (measure of refiner profits) plunged 75% in merely two months.
Recent guidance from BHP (+7%) and Rio Tinto (+11%) point to a sharp increase in copper production signaling strong demand. Rio Tinto’s own smelter projects are coming back online this year, and its guidance suggests refined copper production will surge 40%. This will exacerbate ongoing raw ore shortage.
COPPER FUTURES PREMIUM SURGES TO HIGHEST SINCE 1994
Potential supply disruptions are evident in the market. The contango for copper futures on CME Group is sharply steeper signaling even higher prices in the future.
Source: CME QuikStrike
Front-month futures are trading sharply higher than the spot price. According to Bloomberg, the gap between LME copper 3-month forward and cash market is at its highest since 1994. Copper prices are clearly sensitive to supply side shocks.
CHINA’S RECOVERING ECONOMY SUPPORTS COPPER DEMAND
Copper prices are shining bright. Supply constraint is not the only reason. Demand outlook is promising. Chinese economy has started to build up pace. Outlook however remains uncertain.
Copper is overwhelmingly impacted by industrial and manufacturing activity and growth. Caixin’s China manufacturing PMI surged from 50.9 to 51.1 in March. It marked the fifth consecutive month of manufacturing expansion which augurs well for copper demand. However, demand side headwinds remain. Besides manufacturing, housing is a key sector driving copper consumption. Housing construction consumes copper for wiring and piping. Persistent housing slowdown will drag down copper demand.
TECHNICAL SIGNALS POINT TO BULLISH COPPER
COPPER
GOLD
Both copper and gold exhibit strong bullishness. Technical signals for copper are marginally greater than those for gold. Copper shows stronger positive momentum according to RSI while Gold’s momentum is fading. Gold also faces resistance at its R1 pivot point while copper has found support at its R1 pivot point.
OPTIONS MARKET BODE WELL FOR COPPER RELATIVE TO GOLD
Positioning on CME options market signals that both copper and gold have a bullish outlook. However, copper’s put/call ratio is lower, indicating a more bullish sentiment. Unlike gold, copper has seen a buildup of bullish positioning over the past week too.
COPPER
CME copper options have a put call ratio of 0.44 as of 4/April.
Source: CME QuikStrike
Changes to open interest have been bullish with a larger growth in calls relative to puts over the past week.
GOLD
CME gold options have a put call ratio of 0.72 as of 4/April.
Source: CME QuikStrike
Puts open interest has been on the rise, especially in near-term contracts over the past week.
COMMITMENT OF TRADERS ALSO FAVOR COPPER OVER GOLD
COPPER
Asset managers have switched from net short to net long positioning over the past month in CME copper derivatives. However, the most recent report shows short positioning being built up sharply.
GOLD
Asset managers built up a large net long position beginning March in COMEX Gold. Since then, positioning has since remained unchanged at net long. Asset managers have also been consistently scaling back short positions over the last month.
HYPOTHETICAL TRADE SETUP
Copper is faced with the potential of worsening supply disruptions. Supply of raw ore for refiners is already disrupted, forcing them to become unprofitable.
This situation is likely to worsen as Rio Tinto’s smelting plants come online through the year consuming even more raw ore. Supply of ore is also being cut by miners as they face unprofitable conditions.
Supply of ore is also rising. Australian miners stated that production is expected to rise this year. Supply may become resilient if refiner’s scale back production.
Demand favors copper with consistent economic recovery in Chinese manufacturing. Housing remains a headwind creating downside risk to demand. Copper prices are high and so is uncertainty on the path ahead. Prices are up 10% YTD as of 4/April.
As such, a straightforward long position is risky. Demand at present is not higher, as suggested by the spot discount. In case the disruptions do not materialize, prices could pull back sharply.
Alternative to an outright position in copper is the Gold-Copper ratio which exhibits strong mean reversion.
The ratio is also elevated right now, owing to the massive rally in gold prices through 2024. Gold is trading near its all-time high, which is limiting demand and further price appreciation. Contrastingly, copper is still far from its highs of 2022.
Expecting copper outperformance, a short position in the gold-copper spread can be used to gain exposure to copper’s tailwinds with lower risk.
The following hypothetical trade setup comprises of a long position in CME Micro Copper Futures and a short position in CME Micro Gold futures. The position requires two contracts of Micro Copper for each contract of Micro Gold to balance the notional values. Each Micro gold contract provides exposure to 10 troy ounces of gold (representing a notional value of ~USD 23k. Each Micro copper contract provides exposure to 2500 pounds of copper (representing a notional value of ~USD 10.6k).
• Entry: 558
• Target: 531
• Stop Loss: 567
• Profit at Target: USD 1,402
• Loss at Stop: USD 333
• Reward-Risk: 4.2x
MARKET DATA
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