Cascading copper prices have multiple root causes that lead to one conclusion: The anticipated global economic recovery may not be all it’s cracked up to be.
Consequently, analysts are in virtual unison that the extended-term trajectory is lower for the metal often used as a growth barometer. Copper futures are off more than 12 percent in 2014 and 7 percent over just the past three days, though they rose less than 1 percent in Wednesday trading.
A slowdown in the global economy, forced selling by Chinese banks and technical factors have converged in multiple calls for more weakness in a commodity known by traders and economists as “Dr. Copper” for its ability to accurate make economic prognoses.
“It has been our long-held (and non-consensus) view that copper and iron ore prices were set to fall significantly this year,” commodities expert Caroline Bain at Capital Economics said in a note. “The speed of the recent price falls has taken even us by surprise, but we still see further downside.”
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Bain cited two reasons: “China’s weak industrial activity data is one. Second, the appeal of commodity trade-related financing deals in China appears to be waning.”
The latter factor is particularly intriguing.
Chinese lenders, especially in the nonbank or “shadow” sector, often allow copper to be pledged as collateral. With expectations that the government is going to allow more bond defaults—the first happened last week—lenders are beginning to worry that copper’s value will decline.
“As financial conditions tighten, copper is liquidated when loans are either defaulted on or can’t be rolled over, which can lead to worse financial conditions as companies’ collateral loses value,” Paul Hickey at Bespoke Investment Group explained in a report. “This was the exact same effect that hit the entire U.S. household sector in 2008 when house prices fell, although it’s important to note that a crisis that severe in China stemming from falling copper prices is hypothetically possible but not likely in our view.”
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Commodities pro Dennis Gartman also believes that the banking problems have more to do with copper’s decline than fears over economic troubles.
Writing Wednesday in The Gartman Letter, he theorized:
We’ll argue that Dr.Copper is not sending a signal to the world of impending economic weakness but is instead sending a signal to the world that the banking system in China has very real problems. …
We suspect that some banks have already called in their loans made in this manner, and that what we’ve seen in the past week is the first layer of that loan unwinding; however, there is no way to quantify that notion and we offer it up as it stands, without hard data. However, our fear is that the last banks in … the smaller banks; the regional banks; the banks that are always last to the feeding trough … are still holding copper collateralized loans that have gone from badly performing to horrid to now deeply under water in the matter of days. Panic liquidation has set in; the margin clerks are in charge and it is then that prices make their lows, but there is no way to tell when or where and at what prices those loans shall be finally liquidated.
Whatever the reason, bearish consensus has dominated analyst notes this week.
McNeil Curry, technical strategist at Bank of America Merrill Lynch, said a short-term bounce in copper shouldn’t distract investors because “gains are temporary and should be limited.”
“Big picture, this market remains in trouble,” Curry said.
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Technical analyst Abigail Doolittle at Peak Theories Research noted a multiyear chart divergence between copper and the S&P 500 stock market index, which tend to run in tandem. Doolittle concluded that copper has the economic direction correct and stock market investors, rendered complacent by the Federal Reserve‘s $4 trillion in liquidity injections, could pay the price.
“Irrespective of what copper’s current flirtation with multiyear lows reflects, it is the long-term monthly chart of copper and the S&P that suggests some trouble—some very bearish trouble—may be ahead for both copper and the S&P,” Doolittle said. “In turn, it seems likely that copper will turn out to be ‘right’ about whether 2013 was a false initial reaction in the S&P and one that many investors may come to wish they had ignored.”
—By CNBC’s Jeff Cox. Follow him on Twitter @JeffCoxCNBCcom.