Analysis: Copper vulnerable to price spikes due to shorts

LONDON/NEW YORK Tue Jan 10, 2012 11:52am EST

LONDON/NEW YORK (Reuters) - Copper is more vulnerable to price spikes than other metals because of a large buildup of short positions by money managers, which could lead to short-covering rallies on a change in market sentiment.

Money managers have been betting on falling copper prices for 16 straight weeks, according to the latest data from the U.S. Commodity Futures Trading Commission (CFTC), which showed net short positions in the week to January 6 at 2,007 lots.

This long-running pessimism is based on dim prospects for demand in light of the debt crisis in Europe and uncertainty about growth in China.

"Even a slight improvement in the market sentiment is likely to spark a sharp price rise," said Eugen Weinberg, head of commodity research at Commerzbank.

"The more shorts there are outstanding, the more pronounced the short squeeze reaction might be if sentiment changes," he said, adding that elevated levels of pessimism among financial investors have been a good contrary indicator in the past.

The 16-week net short stretch in the CFTC data is the longest bearish stance money managers have taken since a 52-week run in August 2008 to August 2009.

During that period, their net short holdings peaked at 22,127 lots during the week of February 22, 2009. The subsequent reversal in shorts helped propel the front-month COMEX copper contract from around $2.60 per lb in early August 2009 to its February 2011 record above $4.60.

Benchmark copper on the LME posted its first annual decline in three years in 2011 when it lost a fifth of its value on fears related to the euro zone debt crisis and the global economic slowdown.

Open interest in copper on the London Metal Exchange (LME)has been in decline since mid-December along with copper prices, suggesting long liquidation in the market.

On Tuesday, the metal used in power and construction traded at $7,695 a tonne, up 2.7 percent from a close of $7,496 on Monday.

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Graphic on CFTC data: r.reuters.com/buv87r

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DATA SUPPORTS

Analysts reckon positive developments in the European sovereign debt crisis or improvements in the growth prospects for the United States could prompt a change in market sentiment.

"It is possible that people reverse their short positions if you get resolution ... for the events in Europe. If you get more clarity, people become more willing to take risk," said Nic Johnson, who helps manage about $30 billion in commodities at Pacific Investment Management Co. in Newport Beach, California.

"Copper is one of the markets that has already reflected some of those concerns more than other markets. It could be the start of a good 15 percent bounce-back to the levels ... prevailing back in August and September."

Positive manufacturing data from the United States last week helped propel the metal to a three-week high, while a rise in Chinese copper imports numbers on Tuesday helped the metal break above its 50-day moving average.

Some fund managers, however, are sticking to bearish bets for the metal on the view the outlook for global economic growth remains weak.

"We don't see any reason to be bullish (on copper). The economy is not in great shape, and we're hedging (against) that risk," a source at a hedge fund firm said.

With the beginning of the year marking fund allocations, money managers are likely to start investing again, but with a lot more caution than in previous years.

"In terms of overall investor sentiment, we have come into 2012 with a very different way to how last year began. One thing which is very clear is the all-pervading sense of pessimism that is in the markets at the minute," said Nic Brown, head of commodity research at Natixis.

(Editing by Jane Baird)