A string of remarkable revelations from the copper market have combined in recent days to signal the prospect of a major breakout in the making. As I have done previously with gold and silver, my aim is to bring timely opportunities to the attention of Foolish investors in advance of the metal market's biggest moves.
The mystery trader … revealed
Even as the bank fields investor lawsuits and looming regulatory scrutiny over alleged manipulation of the silver market, JPMorgan Chase (NYSE: JPM ) is back in the limelight, this time involving copper.
The London Metal Exchange (LME) raised eyebrows recently when data revealed a single unidentified trader had amassed a copper position equivalent to at least 50% of the exchange's available supply. The mystery trader's $1.5 billion move to corner a significant chunk of above-ground global supply turned up the heat on a copper cauldron that was already steeping with a looming global supply deficit.
Over the weekend, the plot thickened as London newspaper The Daily Telegraph cited a confidential source identifying JP Morgan Chase as the mystery trader behind this cuprous coup. Now, it just so happens that JPMorgan Chase is preparing to launch a new, "physically backed" copper ETF along the lines of those wildly popular precious-metals vehicles like the SPDR Gold Trust (NYSE: GLD ) . As one LME trader put it: "The story is that they're positioning themselves in front of the ETF."
From the infamous Hunt Brothers debacle of the late 1970s, to the widely observed oddities in silver during the price collapse of 2008, the obvious problem inherent in any one entity controlling a dominant stake in any commodity market is that it renders that market susceptible to price manipulation. Even though I am invested in copper, and I stand to gain from further price increases that may be triggered by dwindling physical stockpiles, I consider this dominant market position a patently unhealthy development for financial markets.
Ian Henderson, a London-based fund manager with none other than JPMorgan Chase, calls copper "the most attractive" of the base metals, adding: "I don't expect any decline in copper demand in 2011 and there is little in the way of new mines coming on stream." The thing is, even when you take that particular forecast with a mountain-sized grain of salt (given his employer's potential outsized stake), Henderson's analysis is absolutely spot-on. The fund he manages, incidentally, has returned more than 700% over the past decade.
And that's the real beauty of copper's outlook here: It was already decidedly bullish on the basis of long-term fundamentals even before this speculative stockpile draw-down.
Anatomy of a global supply crunch
Freeport-McMoRan Copper & Gold (NYSE: FCX ) Chairman James Moffett highlighted the crux of the problem last month when he explained: "The major copper reserves that are being produced today come from 100 year-old mines, with few exceptions." New discoveries of truly world-class copper deposits like Ivanhoe Mines' (NYSE: IVN ) Oyu Tolgoi project are becoming increasingly scarce, and the industry's overall average ore grade has reportedly deteriorated by more than 30% over the past decade (from 1.6% to 1.1%).
In an industry where lag times from first discovery to production commonly extend beyond a decade, I have argued that the violent price decline and simultaneous credit disruptions that paralyzed miners during the commodity crash of 2008-2009 served to curtail the industry's normal capacity to adapt to looming demand for the metal. Some excess mining capacity remains in reserve, with one source estimating the utilization rate at about 80%, but equipment maker Joy Global (Nasdaq: JOYG ) has made it crystal clear that "all copper capacity, including higher cost capacity, will be needed to meet future demand expectations."
Speaking of demand, a recent report by the International Copper Study Group states that apparent global copper consumption increased 8.3% through the first eight months of 2010 (over the corresponding 2009 period), while production grew by only 1%. Barclays Capital estimates global demand will increase by a further 4.2% in 2011.
According to analysts surveyed by Bloomberg, 2011 could yield a supply deficit large enough to consume the entire 350,000-ton stockpile held at the LME. One analyst believes the overall global stockpile may tighten to within one week of consumption. Goldman Sachs' $11,000-per-ton, 12-month price target for copper stands more than 28% above the recent $8,555 price tag for December 2011 futures, which in this Fool's opinion speaks to an upside potential that has yet to filter through the market.
The bullish double whammy
In constructing my own investment theses within the materials sector, my focus is always honed first and foremost upon this long-term secular trend that has clearly dominated these markets over the course of the past decade. Incorporating the broader rise of emerging (and in some cases fully emerged) markets, persistent demand for metals-heavy gadgets like smartphones, the nascent revolution toward greener energy solutions, and of course the dominant underlying trend of deteriorating purchasing power in the world's major currencies, I continue to invest with confidence in base metals like copper.
When a financial giant moves into a specific commodity with a position of this magnitude -- however unwelcome such potential market-tinkering may be -- I perceive the development as further insurance behind the continuity of the trend in play. I believe copper is going higher, and I encourage Fools to participate. Whether one prefers to target a single quality small-cap play like Taseko Mines (AMEX: TGB ) , or cast a wider net with the Global X Copper Miners ETF (NYSE: COPX ) , I see a red-hot future for red-metal investors.