Copper has long been one of the trickiest markets to trade; it has regularly caught the crowd positioned exactly the wrong way and posted vicious moves in the opposite direction. However, in recent weeks the red metal has been unusually placid as it has oscillated near major support at ~$3.00/lb:

Click to enlarge

Copper Weekly (5-year chart)

Copper_Weekly

This is the fourth time in 3 years that copper is testing the $3 area – $3 is an important level not only technically but also psychologically given its round number significance. Technically speaking the chart isn’t pretty; copper has continued to make lower highs since its violent snap-back from the 2011 crash, and the trajectory of bounces has become much flatter (a sign that buyers are becoming less aggressive). However, the commitments of traders data from the CFTC points to a market dynamic which makes it less likely that copper will suffer a large decline despite the chart’s poor technical structure:

Copper_COTSource: barchart.com

Small speculators (mostly trend followers) & large speculators (mostly hedge funds) are substantially short the copper market while commercials (producers and swap dealers) are heavily long. This dynamic does not typically lend to a large decline in a market, however, there are exceptions to everything….

There is another piece of information which helps provide clarity to the copper quandary; a hedge fund named Red Kite has accumulated a roughly $850 million long position in copper based on its analysis that copper will be in supply deficit beginning next year. There are, however, a few problems with Red Kite’s bullish thesis:

  • Global economic growth has recently been downgraded and could continue to disappoint, thus reducing demand for copper.
  • Production shortfalls have been large during 2014 and prices have not responded accordingly

Copper_Supply_Demand

  • Marginal cost of copper production is currently pegged at roughly $2/lb, therefore if demand disappoints and supply surprises to the upside investor liquidations could cause prices to tumble much lower

Copper_Marginal_Cost

There are ample cross currents in the copper market right now. However, one must wonder if a market that is being held up by one primary source (China), especially given that a single hedge fund is holding nearly all of the copper at the London Metals Exchange (LME), will be able to withstand yet another test of major support. The copper quandary is one we will be watching closely for the rest of the year.