Hedge Funds Say Copper Is a Cheap, But Terrifying Trade
(Bloomberg) -- For the handful of hedge-fund traders who built long careers riding the volatility of commodities markets, two things are obvious about copper: it’s cheap and terrifying.
There’s a good argument that the metal -- which is in the midst of a record-breaking 13-day sell off -- is due for a bounce when China gets coronavirus under control. But the chance that the outbreak could still get much worse is keeping some traders on the sidelines.
“Everyone is just so scared of buying,” said George Daniel, a portfolio manager at Red Kite, said by phone from London. “There’s still no one willing to take a stand here.”
“At the very least, you’re going to want to wait until you see the market finish higher,” he said.
Nothing is more important to the copper market than China’s economic engine, which accounts for about 50% of global demand. The country’s manufacturing industry consumes more copper in a week than a mid-size mine produces in a year.
The consensus is that metals demand will snap back when the virus recedes, helped by state efforts to prop up the economy. But until then, the trajectory of the unprecedented virus is unknown.
“If you’re out of the office for four hours, you need to not have a position on,” said Luke Sadrian, a partner at London-based Commodities World Capital LLP, who’s been trading metals for nearly 30 years. “I’m not going to try to be a hero.”
The moment of truth could come soon, when Chinese markets reopen after the Lunar New Year holiday and more information about the scale of manufacturing disruptions starts trickling in. Copper on the Shanghai Futures Exchange is likely to slump by a daily 7% limit at the opening of trading.
On the LME, copper has been in freefall. Prices sank 9.8% to $5,567 a ton in January, marking the worst month since 2015.
The arbitrage between London and Shanghai stands at $577 a ton, the widest since 2013, according to Bloomberg calculations.
Traders will be watching whether London prices rise to close the gap, or Shanghai contracts will keep dropping beyond Monday’s plunge.
In the U.S., money managers cut their bullish bets at the fastest pace in more than eight years in the week ended Jan. 28. That resulted in a net-short position of 20,198 futures and options contracts, according to the latest data from the Commodity Futures Trading Commission.
For now, copper still looks like a sell to the algorithmic trading systems that have become the predominant speculative force on the London Metal Exchange. These systems, known as commodity-trading advisors, remain a threat until the streak of losses ends, according to Daniel.
“I’ll be up at 1 a.m. on Monday morning to watch the market open, probably with a decaf cup of tea,” he said. “I expect I’ll just be thinking: Wow, so what do I do now?”
With plants staying closed for longer, there’s a likelihood that metal inventories will be building in the Chinese spot market in the coming weeks. That could drag on prices, even as authorities start to get the virus under control.
In the longer term, the key question is how far the government will go to support the economy.
“For the first time in a long time, we have the prospect of large-scale interest rate cuts,” said Sadrian of Commodities World Capital. “The possibility that China will get out that blunt, heavy instrument to get growth back on track is probably the reason why copper hasn’t completely melted down yet.”
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