November 11, 2016 / 1:26 PM / 9 months ago

Man or machine? Explaining copper's extraordinary rally: Andy Home

An employee carries copper hoses at the Sociedade Paulista de Tubos Flexiveis (SPTF) metallurgical company which manufactures flexible metal hoses, in Sao Paulo April 20, 2012.Nacho Doce/File Photo

LONDON (Reuters) - It will probably go down in the history books as the Trump Rally.

Copper is on course to record its biggest weekly rally in 35 years. It's a stand-out even amid the turbulence that has rocked the broader financial universe.

Trading volumes have gone super nova.

The London Metal Exchange (LME) has seen over 205,000 lots trade on its benchmark three-month contract since Monday, already an all-time weekly record and the week isn't over yet.

On the CME copper traded 256,017 contracts on Wednesday, also an all-time daily record.

The entire global copper market, it seems, has been repositioned from bear to bull territory in a matter of days.

And while there is no doubt the election of Donald Trump as U.S. President has acted as an accelerator, there is more to this explosive price action than as yet vaguely-defined promises of infrastructure spending and reflation.

Copper's extraordinary 20 percent (and still counting) price surge has been as much machine-made as man-made.

REASSESSING THE NARRATIVE

This rally began last month. On Oct. 25 to be precise.

LME three-month copper opened that day at $4,649 per tonne and closed at $4,735. It has since recorded 14 consecutive days of higher closes.

Two weeks ago only Trump and his supporters really believed he would beat Hillary Clinton in the race to the White House. The markets certainly weren't pricing in a Trump victory.

Rather, the copper market, particularly the speculative part of it, seems to have started reassessing the prevailing copper narrative of chronic over-supply.

There was a noticeable shift in mood during the ensuing LME Week.

Chinese demand, everyone agreed, has been running at a much faster pace than originally expected thanks to the government's early-year stimulus package.

Supply disruption, conspicuous by its absence in the first half of the year, was suddenly back on the agenda as the Q3 reporting season brought a series of production downgrades from major producers.

And with LME inventory falling fast and Shanghai Futures Exchange (ShFE) stocks low as well, there was little tangible sign of that much feared "wall-of-copper".

Fund money started flowing into the copper market in ever increasing quantities.

The LME's Commitment of Traders Report showed that the net money manager long position as of last Friday had already hit its highest level since the exchange started publishing its weekly report in 2014.

The weekly close on Nov. 4 was $4,991, the highest since April.

Graphic on copper's technicals; key resistance areas:

tmsnrt.rs/2fHQ1gJ

Graphic on long-term trend line and Fibonacci retracements:

tmsnrt.rs/2fCleC6

ROBOTS RUN RIOT

That close was right at one of those big-number levels, $5,000 per tonne, so beloved of chart technicians.

Another key big-number level was at $5,100 and an even hotter chart point was up at $5,400.

It's noticeable that copper's rally accelerated on each break of these technical levels, a clustering of historical resistance levels, long-term downtrend lines and Fibonacci retracement points.

Without going into the esoteric world of chart analytics, there are two takeaways from such technicals.

Firstly, copper had been defined for almost a year by range-trading with every part of the market, from producers to consumers to speculators, positioned around that range.

Breaches of those trading bands caused a mass repositioning with short positions closed out, long positions put on, new short positions put on only to be closed out again as the price kept motoring upwards.

One very public example was Goldman Sachs issuing a research note on Thursday saying it was closing out its short March 2017 copper vs March 2017 half unit zinc long position after reaching a stop-loss of minus eight percent.

"This was driven by losses on the copper leg that more than offset the gains on the half unit zinc long," the bank said. ("Metal Detector - Reflation Rotation."

Secondly, many Commodity Trading Advisors (CTAs) plug chart technicals into their algorithms, causing a snowball effect as key resistance levels are taken out.

Momentum trading funds then join the feeding frenzy and high-frequency funds amplify the effect as they are programmed to pre-empt other automated trading systems.

Think the copper market equivalent of Skynet, the artificial intelligence network that takes over the world in the Terminator films.

OPTIONS ACCELERATORS

That $5,000 level had added significance for option traders. Options open interest is also often clustered around such big-number levels.

LME market open interest on the December $5,000 call options totals around 90,000 tonnes. Adding in January and February and the figure rises to 200,000 tonnes.

Sellers of those options would have had to buy futures to cover their exposure, the exact "delta" dependent also on computer models.

Indeed, copper's ascent to this morning's high of $6,025.50 per tonne has brought into play around 525,000 tonnes of open call options across the three front months.

Options sellers covering their exposure would have added fuel to an already red-hot market.

THE ECHO CHAMBER

The last part of copper's price rally has been driven by Chinese players waking up to what has been happening in the rest of the world.

The Chinese retail crowd have been playing other markets, particularly the Shanghai and Dalian ferrous contracts, in recent weeks.

Copper has been relatively neglected, precisely because it seemed so boringly range-bound.

That's changed this week. Market open interest on the Shanghai copper contract had fallen to a three-year low of 439,784 contracts at the end of September.

It has since risen to 552,572 lots (and counting) with volumes spiking as the price has soared. That's a whole new buying impetus coming in from what LME broker Marex Spectron termed in Friday's morning report the "onshore casino".

It's a catch-up play but one that is now hitting the copper market at precisely the moment many Western players are looking to take some profits.

Chinese investors trade what moves and what is hot with rises in open interest fanning further buying in what is a mass human echo effect of how momentum funds operate in the West.

MAN OR MACHINE?

This week's extraordinary rally will still go down in the history books as the Trump Rally.

But in truth even the influence of the extraordinary Donald Trump has been trumped by the power of the program traders.

This rally started in late October with a human reassessment of copper's underlying dynamics but this week the robots have taken over.

It's a sign of the times. Other markets have learned the robots' power. This is probably the first time the base metal markets have experienced it.

It won't be the last time.

(The opinions expressed here are those of the author, a columnist for Reuters)

Editing by David Evans

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