Isra-Mart srl: Illusions versus Reality in the Copper market

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“You unlock this door with the key of imagination. Beyond it is another dimension, a dimension of sound, a dimension of sight, a dimension of mind. You’re moving into a land of both shadow and substance, of things and ideas. It’s a journey into a wondrous land, whose boundaries are that of imagination. That’s a signpost up ahead, your next stop, the “Twilight Zone!”

Rod Serling was a multi-talented man and a prolific writer. His television series “The Twilight Zone” ran for five seasons in the early 1960’s and was extraordinary, winning three Emmy Awards. As the host and narrator, and writer of more than half of 151 episodes, he became an American household name and his voice always sounded a creepy reminder of a world beyond our control. For many traders in the commodity pits, every trading day is like entering “a fifth dimension beyond that which is known to man, that lies between the pit of man’s fears and the summit of his knowledge. It is an area called the “Twilight Zone,” Serling used to say.

Such has been the case for the once high flying Copper market, which touched an all-time high of $4.6250 /pound, in February 2011, yet last week, briefly plunged to as low as $3 /pound, and tumbling -35% below its all-time high. Most of the slide occurred within a nine week period, starting on August 7th. It was the most rapid downward spiral the copper market has experienced since the “Crash of 2008.” Hedge fund traders, that control as much as $2-trillion is customer funds, were reported to be selling a wide array of commodities, including, corn, gold, silver, soybeans, and copper, in order to meet redemption calls by jittery investors, who were shell shocked by $11-trillion of losses in global stock markets.

Yet how does one explain the sudden sharp drop in copper prices that sliced off a third of its value? At last count, global demand for copper is not too far from record highs, and furthermore, demand for copper is expected to exceed new supplies by roughly 200,000-tons this year, leading to a supply deficit, which should buoy copper prices. “There has been some softening in copper demand, but not to the extent seen in the copper price,” said Richard Adkerson, chief executive of Freeport McMoRan Copper & Gold FCX.N, the world’s largest publicly traded copper miner. “There’s this disconnect right now, and that’s because investors are concerned about the future. There are huge macroeconomic uncertainties, and it’s driven by that,” Adkerson said. In other words, the traders in the copper market are operating in the Twilight Zone, where its difficult to separate illusion from reality.

Part of the reason for the sharp slide in the copper market since August 7th, are indications that activity in the global factory sector has slowed down to stall speed. On Oct 3rd, JP-Morgan reported that the Global Manufacturing PMI had contracted worldwide for the first time in over two years last month as incoming orders for new work dried up. The Global Factory PMI fell in September to 49.9 from 50.2 in August, the first time since June 2009 that the index has fallen below the 50-mark that divides growth from contraction, after sliding for the last seven months. More ominously, the New Orders index fell to 48.5, down from 49.4 in August, it’s lowest since May 2009 and the third straight month it has been below 50.

On Oct 4th, Fed chief Ben Bernanke to Congress that “the US-economy is close to faltering,” and Goldman Sachs warned that the US-economy is on the edge of recession. “The European crisis threatens US-economic growth via tighter financial conditions, reduced credit availability and weaker growth of US-exports to the region. This impact is likely to slow the US- economy to the edge of recession by early 2012,” Goldman said. Earlier, the Economic Cycle Research Institute also warned that the US-economy was already past the point of no return, and beyond the ability of policymakers to help. “The most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not soft landings,” the ECRI said in a report.

All these forecasts and reports conjured-up the illusion of an impending “double-dip” recession in the Trans-Atlantic economy. However, sentiments can turn on a dime in the commodity markets, especially when central banks intervene to try and change the realities. On Oct 4th, Bernanke stopped the panic on Wall Street, when he strongly suggested to Congress that he would unleash the Fed’s nuclear option, “QE-3,” to inflate the stock market’s value. Over the next few days, the S&P-500 soared by +8%, and escaping the grasp of the grizzly Bear.

Still, the magnitude of the recent collapse in copper prices is very surprising, considering that the global demand for copper has increased by an average of +4% per year for the past 110-years. Furthermore, the size of the world’s population is increasing 80-million persons each year, thus placing even greater demands on the world’s resources. On June 22nd, Bank of Canada Governor Mark Carney highlighted this point, saying that populations in “China and India are increasing by the entire size of Canada’s population every year and a half. The middle class globally is growing at 70-million people a year, so just the marginal demand for these commodities is enormous and being driven by the major emerging markets. We see strength in commodity prices persisting for some time,” Carney said.

Yet three months later, the Continuous Commodity Index, a basket of 17-equally weighted commodities suddenly nosedived -15%, skidding to as low as the 560-level on October 5th, as traders dumped a wide array of commodities, including aluminum, corn, soybeans, sugar, silver, cocoa, nickel, natural gas, crude oil, coffee, and wheat. Of all the top commodities however, copper was the hardest hit. What compelled traders to dump this highly prized metal and other important commodities, in a panicked selling spree, when the reality is, there’s the inexorable increase in the world’s population background, that’ll boost demand, irrespective of the swings in the global business cycle?

As Albert Einstein used to say, “Reality is merely an illusion, albeit a persistent one.” Instead, traders were gripped by fear of Armageddon. The specter of a banking crisis in the Euro-zone was haunting frightened traders, after the interest rate on Greece’s 2-year note briefly soared to as high as 100-percent. Likewise, the yield on its 10-year bond jumped to 24.75%, knocking the price of the Greece’s 10-year bond to 36-cents per Euro. The odds are very high that Athens would default on its 357-billion Euros of debt, and based upon current prices, traders expect that the Euro-zone’s Oligarchic bankers would be forced to take a “haircut” of about 60% on their toxic holding of Greek bonds.

“Greece is bankrupt,” said Michael Fuchs, a deputy parliamentary floor leader for the Christian Democrats in the Bundestag, reflecting a growing mood of deep pessimism in Berlin. “Probably there is no other way for us other than to accept at least a 50% forgiveness of its debts,” Fuchs told the Rheinische Post newspaper. Hedge funds began dumping commodities, fearing that nervous bankers would call in margin loans, extended in ultra-cheap US-dollars.

The panic on the stock markets shows that if Greece defaults on its debts, it could trigger a deep recession in the Euro-zone, that’ll eventually spill over to the US-economy, which is already beset by stagnating growth and a high jobless rate. There are worries that companies would respond with new waves of layoffs, while Euro-zone governments are forced into further austerity, thus guaranteeing a “double-dip” recession.

The political elite of France and Germany have no choice but to bow to the demands of Europe’s banking Oligarchs, by placing a firewall around this “too-big-to-fail” cartel. Finance official and central bankers will deny the possibility that Athens would default on its debts, - until it actually happens! While buying some extra precious time, France and Germany are preparing the groundwork for an orderly restructuring of Greece’s debt by year end. The reality is, Europe’s banking Oligarchs would survive, but could end up as zombie banks.