Bullish Copper Technicals

Copper is growing increasingly popular among speculators, who are catapulting this unassuming base metal up into the rarified ranks of market-darling commodities. Neither precious like gold, nor immediately consumed like oil, copper's price action is quite unique. And despite some risky headwinds remaining, its technicals are once again turning bullish today.

I last wrote about copper in mid-February, as it hit new all-time highs of $4.60 per pound.My essay then concluded, "The bottom line is copper is due for a major correction. Sentiment in this metal is wildly bullish thanks to its recent massive upleg and new all-time highs. Copper is very overbought technically, it has rallied too far too fast by its own bull-to-date standards. And it has ignored a major trend change in its LME stockpiles in order to follow the stock markets higher."

This contrarian prediction came to pass. In the 5 months or so since, copper has not only failed to regain those lofty heights but has indeed corrected. Over several months ending in mid-May this base metal gradually ground 15.9% lower. It surrendered nearly 1/6th of its value in the global marketplace! Copper needed to correct for the reasons I articulated in mid-February, and the selling arrived as expected.

But ever since those mid-May lows, copper has been consolidating and gradually clawing its way higher. This was pretty darned impressive considering some of the stock-market action over the 2 months since. Copper is usually highly correlated with the stock markets, heavily influenced by general sentiment. Yet in the first couple weeks of June when the flagship S&P 500 stock index plunged 5.9%, copper only lost 0.8%. It was truly a remarkable display of relative strength for this economically-sensitive metal.

This resilience probably means one of two things. Copper's correction could have been big enough and long enough to fulfill its mission of rebalancing sentiment. If its magnitude was sufficient to eradicate the greed of mid-February and usher in fear, then most of the bearish traders were probably squeezed out. This means there weren't many sellers left in early June, which is a bullish sign for copper prices.

Alternatively, copper simply might not have followed the stock markets' fast swoon lower then because it didn't generate much meaningful fear. Copper gets crushed in fear-laden stock selloffs because they lead futures traders to assume global economic growth is in jeopardy, which would retard copper demand growth. If this thesis is correct, and the stock markets start falling again, copper could still get hit hard.

But exogenous sentiment influences aside, copper's intrinsic technicals are certainly looking bullish. So traders ought to give it the benefit of the doubt today, while remaining vigilant for a stock-market selloff that could bleed into this popular base metal. This first chart examines some of the bullish copper technicals today. This metal's price itself is rendered in blue and slaved to the right axis.

Copper has certainly enjoyed a spectacular run since 2008's once-in-a-century stock panic. Between its panic low in December 2008 and its latest high in February 2011, this metal soared an astounding 261.0% higher. That might seem excessive, but realize it is mostly just a recovery after that hellstorm of fear spawned by the panic ripped copper to shreds. Between July 2008 and December 2008, it plummeted an apocalyptic 68.7%! Over 2/3rds of its value vaporized in just 6 months!

We capitalized on those ridiculously irrational and oversold copper prices by aggressively buying copper stocks. An elite-copper-stock long-term investment we recommended to our subscribers in the heart of the stock panic was up 277.8% as of this week! Those panic lows were just absurdly silly. That crazy panic anomaly aside, between its July 2008 and February 2011 highs copper only rallied 13.0%. Far from excessive, this is downright trivial.

So it's not righteous to look at copper's post-panic surge in isolation and claim this metal must be in a bubble. In broader secular context stretching back several years before 2008's panic, copper's bull has actually been very modest. While the blistering pace of copper's post-panic recovery won't be sustainable indefinitely, copper should still continue gradually marching higher on balance. At least as long as its secular fundamentals remain bullish, with its global demand growth outpacing supply growth.

As for its current bullish technicals, note that copper's recent grinding 15.9% correction over 2.9 months dragged it back down to a couple critical support lines. The first, and most important by far, is copper's 200-day moving average. In ongoing bull markets, 200dmas are generally the highest-probability bounce points for healthy corrections to bottom.

And after copper first hit this key metric in early May, it spent the better part of 8 consecutive weeks bouncing along it. The longer a price lingers and climbs along a major support line after a correction, the more likely a true bottom has indeed been seen. And 8 weeks is an awfully-long time, especially since this span encompassed that big early-June selloff in the stock markets that copper nonchalantly shrugged off.

In addition, since this latest correction bottomed a secondary support line has held for just as long. Note above that the lower support of copper's well-defined post-panic uptrend has held strong. The last time this particular support line was approached was back in the summer of 2010 after copper's last major correction. That earlier selloff was driven by a parallel correction in the stock markets, which is one reason why any new stock correction poses big downside risk for copper.

That same uptrend support line that held strong in the summer of 2010 has so far held strong in the summer of 2011. This is a great secondary confirmation of a probable copper trend change from correction mode to new-upleg mode. But personally, I believe the 200dma holding is far more important. Copper can't continue surging at its outsized post-panic-recovery pace indefinitely, so at some point this recovery uptrend's support line will fail even though copper's secular bull remains intact.

But while copper's technicals look bullish based on holding strong at multiple support lines for a couple months, all isn't rainbows and unicorns. Relative to its 200dma, copper never hit very-oversold levels in its recent major correction. This significantly increases the odds that the correction might not be over yet, that we may have to see another low before the next upleg begins. This is based on my successful and profitableRelativity trading system.

Interestingly if you take any price in a secular trend and divide it by its own 200dma, the resulting multiple forms a horizontal trading range. This multiple for copper is rendered above in light red, slaved to the left axis. If you flattened the black 200dma line to horizontal, and recast the blue copper-price line as a perfectly-comparable-percentage multiple of it, the result is the Relative Copper (rCopper) line.

Over time, this rCopper construct forms definite support and resistance zones. We define these based on where rCopper has meandered over the latest 5 calendar years. Our subscribers can log in to our website and look at the large high-resolution long-range chart (updated weekly) we used to define copper's relative trading range. Today it runs from 0.90x on the low side to 1.20x on the high side. In other words, copper tends to trade between 90% to 120% of its own 200-day moving average.

Unfortunately when copper bottomed in mid-May, it was only at 0.971x relative. It wasn't super-oversold yet, fear simply wasn't extreme enough, as defined by copper's bull-to-date precedent. Contrast this with rCopper's deep 0.883x relative low back in June 2010 after its last major correction. While copper's recent support-hugging behavior for a couple months after its mid-May low suggests a durable bottom, the lack of a deeply-oversold rCopper reading at that time certainly undermines this.

It's not that copper remained overbought in mid-May, far from it. But it just wasn't as low yet as major corrections have tended to drag it over the past 5 years or so. This means that despite copper's bullish technicals, it likely remains very susceptible to fear splash damage driven by any renewed stock-market selloff. So if the S&P 500 starts falling fast enough to spark real fear, odds are copper will be sold in sympathy. And it will probablyhit a new low in this scenario, extending its recent correction.

Because of this ambiguity, I thought about not even writing this essay. But this is simply the way the markets usually work. While there are those rare times when all the indicators line up perfectly to herald a high-probability-for-success buying opportunity or selling warning, most of the time everything isn't in agreement. The more indicators that agree the better the odds, but they still never approach certainty.

This next chart shows a key fundamental copper-price driver that helps offset the lack of an ideal rCopper low. It is the levels of the London Metal Exchange's copper stockpiles. The LME runs a global network of warehouses that act as a buffer between copper miners and consumers. While most copper mined is shipped directly from producers to consumers under contract, occasionally a miner will have excess production beyond contract or a factory will need more copper than usual.

So the LME warehouses around the world provide places where this excess physical copper on the margins of global supply and demand can be traded between producers and consumers. Each day the LME publishes these total copper stockpiles, which are eagerly watched by speculators. Rising stockpiles mean copper's global supply-demand imbalance isn't as tight, so prices are likely to fall. And declining stockpiles reveal tightening supplies, which usually leads traders to bid up copper.

Because of the wild dislocations spawned by 2008's stock panic, the relationship between copper prices and LME stockpiles isn't as clear since then. But if you look at alonger-term chart, it is readily apparent that prices and stockpiles naturally have a strong inverse relationship. The farther the stock panic recedes into the rearview mirror and the more conditions return to normal, the more this logical relationship will reassert itself. With copper now recovered into its pre-panic secular uptrend, stockpiles are important again.

Given the big numbers of and diversity in both the global copper miners and the factories that fabricate finished goods using this copper, it isn't surprising that changes in aggregate supply and demand move slowly. It takes many months to ramp up mine production or factory production, output changes can't happen overnight. Thus the LME stockpiles tend to slowly meander in low-volatility trends. Note how straight the red stockpile lines are compared to the blue copper price.

And whenever major trend changes happen, from copper tightness to relative abundance or vice versa, they tend to be gradual and decisive. There aren't many instances in this bull where LME stockpiles started moving the opposite direction for a month or two where it was merely a head fake. Once supply started outpacing demand or vice versa, the resulting trend changes tended to be durable and sustained.

Note above that back in mid-June soon after copper's latest bottoming, global LME copper stockpiles peaked near 478k metric tons. In the month or so since, they have been relentlessly drawn down by a material 3.4%. While it is possible this trend change will soon reverse and copper stockpiles will begin rising again, it isn't probable in light of LME stockpiles' bull-to-date precedent. And if extra copper continues to be bought out of the LME's warehouses, traders are likely to bid copper prices higher.

The last couple major draws in LME copper stockpiles are crystal-clear in this chart, a huge 53.2% draw ending in mid-2009 and a longer 37.2% one ending in late 2010. Since stockpiles didn't get up to their post-panic trading range's resistance of 550k tonnes in their recent peak, I certainly don't expect a drawdown of this magnitude. But it would still be perfectly normal for stockpiles to trend down towards their 350k support line. This is another 112k tonnes of copper likely to be drawn over a couple quarters!

If this LME stockpile trend change is durable and sustained, and it gradually heads back down towards its post-panic support, it is hard to imagine speculative capital not flowing back into copper. While copper is still at risk of getting sucked into the fearful sentiment in a material stock-market selloff, falling LME stockpiles will almost certainly dampen its impact on this metal. Bullish fundamentals always generate a tailwind.

So not only are copper's intrinsic technicals looking pretty bullish, its supply-demand fundamentals are providing confirmation. Though a stock-market selloff couldtemporarily drag copper to new correction lows, this setup is bullish enough to start a gradual deployment into the beaten-down copper stocks. We just started buying and recommending copper stocks again in our subscription newsletters, with more to come soon if copper's technicals and fundamentals remain favorable.

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The bottom line is copper's technicals are looking pretty bullish today. Even though copper's latest correction didn't leave it quite as oversold as it was after past major corrections, its price action has been excellent since. Major support lines have held strong, even during a sharp stock-market selloff. On top of this, global copper stockpiles appear to have just turned the corner into a new bullish drawdown mode.

Given the stock markets' strong influence on copper traders' sentiment, there is still a decent chance that any new stock-market selloff sharp enough to generate fear would drag copper back down. It may even fall far enough to hit new correction lows. Nevertheless, since it has just corrected and its fundamentals are now bullish again, any stock-driven selloff is likely to be short-lived and a fantastic buying op.

Adam Hamilton, CPA

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