Bullish Copper Bets Go Wrong as Hedge Funds Ignore Warnings

(Bloomberg) - Hedge funds ignored the warnings about the red-hot copper market, and it may have cost them.

After amassing their largest holdings ever, money managers saw the value of the metal plunge last week, halting the longest rally in a decade. While global copper supplies are tightening, Barclays had warned clients in August that production shortfalls were “over-hyped,” and Goldman Sachs said the metal was about 10 percent above fair value. Even Oscar Landerretche, chairman of top producer Codelco, had said the gains weren’t sustainable.

“Copper, really, is riding a wave of speculative fervor,” said Chad Morganlander, a Florham Park, New Jersey-based money manager at Stifel, Nicolaus & Co., which oversees $240 billion. “A pullback like this shouldn’t be a shock to anyone.”

Hedge funds and other large speculators increased their net-long copper position, or the difference between bets on a price increase and wagers on a decline, by 0.4 percent to 125,376 futures and options contracts in the week ended Sept. 5, according to U.S. Commodity Futures Trading Commission data released three days later. The short position rose for the first time in six weeks.

Copper futures for December delivery on Comex in New York fell 2.5 percent last week, ending an eight-week run of weekly gains for the most-active contract, the longest since May 2006.

Supply concerns are easing after Phoenix-based Freeport-McMoRan said on Aug. 29 that it is preparing to sell a majority stake in the Grasberg copper mine to local investors. The move is part of an effort to end a dispute with the Indonesian government over terms of its contract to operate in the country.

The accord could reduce the risk of further disruptions in production and may even lead to a “positive surprise” in 2018 mine output, Standard Chartered said in a report on Sept. 4. Expectations for a rebound in supply could weigh on prices, analysts at the London-based bank including Nicholas Snowdon said.

Disruptions at Grasberg and BHP Billiton Ltd.’s Escondida mine in Chile pared global output in the first five months of the year, causing a shortfall in refined metal for three straight months through May, according to the Lisbon-based International Copper Study Group.

This year’s deficit will total 156,000 metric tons as mine production growth slows amid stronger Chinese demand, Dane Davis, a Barclays analyst, said in a note dated Aug. 29. Still, he said the current supply conditions won’t last and that prices could decline by the fourth quarter. In a separate report, he called copper above $3 “overvalued and unsustainable.”

Goldman analysts led by Jeffrey Currie said in a Sept. 4 note that while “strong economic data and solid supply and demand fundamentals played an important role in the copper rally,” the metal has already climbed above its fair value of $6,200 a ton ($2.81 a pound).

Falling copper premiums, as well as relatively cheap scrap supply and the growing speculative positioning point to “near-term weakness for copper prices,” Deutsche Bank AG analysts wrote in a note received Monday. Premiums — the amount paid over exchange prices for spot delivery — fell in the China import market to $66 a ton by the end of August, from $72 at the end of July, according to SMM Information & Technology Co.

Even with those cautions, some investors say copper’s stumble last week is unlikely to persist given the outlook for robust demand and declining stockpiles. Combined inventories in warehouses tracked by exchanges in New York, London and Shanghai fell for a fourth straight week to the lowest since January.

Goldman said in its Sept. 4 note that the bank’s technical analysis suggests a copper target price of $7,350 a ton, as momentum signals further upside risks.

The JPMorgan Global Manufacturing Index advanced for a second month in August to the highest since at least 2014. In China, the largest copper user, the official factory gauge rebounded in August, underscoring expectations for increased copper consumption.

BMI Research said the metal will enter a supply deficit this year that could deepen to 2021.

Demand for the metal used in pipes and wiring may get an additional boost as areas swamped by Hurricanes Irma and Harvey rebuild homes and replace cars. Irma, which has already destroyed 95 percent of homes on the small island of Barbuda, was estimated by Barclays to cause insured losses of as much as $130 billion when it hits the U.S., under a worst-case scenario.

“The price pretty much got overstretched, despite fundamentals being somewhat supportive,” said Rob Haworth, a Seattle-based senior investment strategist at U.S. Bank Wealth Management in Seattle, which oversees $148 billion. “Over the longer term, there’s reason for prices to stay this high. Fundamentals are coming in line. The oversupply seems to have been mitigated, at the very least.”