Hocus Pocus
Fundamentals
Like a magician, the Fed made over one trillion dollars magically appear out of nowhere, stoking fears that deflationary pressures will give way to sharp inflation. The central bank has been relatively quiet in recent weeks leading up to the policy statements, and the market expected the Fed to increase purchases of bad assets from banks. The scope of the long-term treasury and mortgage purchase plan, though, shocked virtually every market observer, causing a spike in equities, bonds and commodities. At the same time, the Dollar Index dropped sharply over the past two sessions due to the sharp upswing in money supply. This sets the groundwork for inflationary pressure to creep back into the market. Commodities may once again become an attractive place for investors to divert their funds because of the uncertainty in equities and minuscule bond yields. Given the sharp devaluation of Copper in the second half of last year, the yellow metal may be in a better position to gain than other commodities. Like the US, China has been aggressively trying to stimulate its economy, potentially setting up for a sharp upswing in purchasing after months of declining demand. The purchase of long-term treasuries by the Fed is aimed at pushing down yields to force businesses to invest in new projects instead of aggressively saving. Also, the central bank hopes to stimulate the housing market by pushing mortgage rates lower. Both of these factors could spark a revival in domestic demand. The combination of physical buying and sharp decreases in mine production has brought inventory levels on the LME below 500,000 metric tons, after peaking at nearly 550,000 metric tons.
Copper prices seem to be coming back to more realistic levels, after falling to nearly $1.25 earlier this year. Given the recent technical breakout above the $1.70 mark and strong fundamentals, it appears as though prices may continue to move higher. The Copper futures contract is extremely volatile, often moving 500 or more points intra-day, which can be difficult for many traders to stomach. This volatility also causes options to be on the pricey side, which is why a bull call spread may be in order for traders wishing to take the long side of the market. Traders believing that Copper will move above the $2 mark by the July options expiration date may want to enter a bull call spread, buying the July 1.90 call and selling the July 2.00 call for a premium of 350 points or lower. The cost of the trade is $875, with a maximum profit potential of $1625.
Technicals
The July Copper chart shows a breakout above the 1.70 level last week, adding further confirmation to the initial breakout above the 1.60 level. Prices closed on the downtrend line formed by the July, August and October highs, suggesting that an overall trend reversal may be in the works. The 50-day moving average is nearing and upward crossover of the 100-day average. If and when such a moving average crossover is confirmed, this can be seen as confirmation that the prior downtrend may be giving way to a new uptrend. The previous resistance area at 1.70 can now be seen as support, while the July contract may see minor resistance at 1.8890. The market is nearing overbought levels on the RSI indicator, suggesting prices may come down to test newly established support or move sluggishly higher. Further technical breakouts while in overbought conditions, however, can be seen as extremely bullish. While the RSI is typically used by traders to gauge overbought and oversold conditions, history tells us that bull rallies confirmed on overbought readings tend to be especially strong.
Rob Kurzatkowski, Senior Commodity Analyst
