LONDON (Reuters) - History may not repeat itself but it certainly does rhyme strongly when it comes to the copper market.
Back in January the London Metal Exchange (LME) price slumped by over 11 percent over the course of two days to touch what was then a near-six year low of $5,339.50 per tonne.
Chinese funds led the bear charge, aided and abetted by like-minded investors elsewhere, with LME options positioning acting as a downwards accelerator.
Now, once again, Chinese speculators are cranking up the short-selling pressure and on Tuesday copper hit a fresh six-year low of $4,590 per tonne.
Once again embedded layers of options are exerting a magnetic pull lower.
Sure, there are differences this time around.
January’s implosion was exacerbated by liquidity black holes with the Shanghai Futures Exchange (SHFE) contract going limit-down and forcing order flows into the LME market in the wee hours of the London morning.
This time the collapse has been more orderly but no less severe, LME three-month copper falling over 12 percent from its Nov. 4 high of $5,220.
With hindsight that Chinese bear raid back in January was a warning of what was to come in terms of just how hard Chinese economic “slowdown” would hit the industrial metals complex.
Is the current massing of Chinese copper bears another warning sign?
(Graphic on Shanghai copper price, volume and open interest: tmsnrt.rs/1l5hvgZ)
In Shanghai the slide in copper prices has been accompanied by sharp increases in both open interest and volume.
Total market open interest hasn’t yet hit the January highs, which were an all-time record, but it has surged by almost 33 percent over the course of November.
Volumes have spiked over the last few days and are now close to the year’s highs hit during both the January sell-off and another slump in July.
The combination of rising volumes, rising open interest and falling price is a classic indicator of increased short positioning.
Alas for headline writers everywhere, the exotically-named Shanghai Chaos fund is not currently gracing SHFE’s list of major short position holders as it did back in January.
However, the two biggest shorts on the SHFE January 2016 contract, the most currently active, are Haitong Futures and Donghai Futures, both of which were prominent in the January sell-off.
As such, it certainly looks as if Chinese bear funds are once again expressing a collective bear view of copper’s immediate prospects.
And investors elsewhere seem to be following their lead. Money manager short positioning on COMEX has flexed out sharply since the start of the month. At 19,398 lots, it is already greater than in January but still off August’s extremes.
The LME’s Commitments of Traders report shows money managers still net long but it is now widely recognized that the LME’s reports have a built-in long bias.
The key point is that the collective long positioning has fallen sharply since the start of the month to 11,861 lots as of last Friday.
Where Chinese funds lead, in other words, others are happy to follow.
(Graphic on LME Dec put options positioning: tmsnrt.rs/1l5hUzP)
In London, meanwhile, options positioning is coming into play in the same way it did back in January.
December is always a highly liquid month for LME-traded options and this year is no exception.
There are large put option positions, which confer the right to sell, stretching all the way down to $3,000 per tonne. Using the $5,200 level as a cut-off, because that’s roughly where the price started the month, total downside exposure on December options has been around 850,000 tonnes.
The slide in prices has brought around 318,000 tonnes of that “into the money”, meaning options sellers have had to hedge-sell that tonnage, adding to the downwards pressure.
Moreover, there are further big clusters of open interest on the $4,500, $4,400 and $4,000 strike prices; 3,683 lots, 1,766 lots and 7,649 lots respectively.
These downside put options are not just speculative punts on where buyers think the price may go.
They may be components of producer hedging programs or even “safety-net” hedges for long position holders.
But for the sellers, the origin of the exposure is of secondary importance. The further the price falls, the more they have to hedge-sell their exposure, a risk-management practice called “delta hedging” in the options world.
The proximity of December options declaration date, Dec. 2, heightens the sensitivity to moves in the outright price.
Moreover, what shows up in the LME’s official market open interest figures for options may well be but the cleared tip of a bigger over-the-counter iceberg.
Indeed, the sheer tonnage of downside exposure represented by these put options was always going to offer bears a tempting target.
And quite evidently, for there is no shortage of further downside options-related targets.
At the start of this year most analysts were still scratching their heads as to what was happening in China, the driver of global copper demand growth.
Chinese hedge funds, it seems, had already made up their mind that whatever was around the corner wasn’t going to be good, and they voted with their wallets.
Should we be worried that they are evidently doing so again? Particularly since, this time around, it’s not just copper that is being singled out for the bear treatment. Shanghai open interest has spiked in both zinc and, unusually, aluminum.
For Goldman Sachs, the answer is yes.
“In our view, this development raises a red flag regarding ongoing and near term activity in China’s ‘old economy’ and metals demand growth,” it said in a research note (‘Metals raise red flag on China’s ‘old economy’, Nov. 17, 2015)
“Indeed, over the past five years, periods of rising SHFE open interest and falling metals prices have been associated with concurrent or imminent weakening in China’s commodity intensive ‘old economy’,” the bank argues.
Which makes sense. Who, after all, is better positioned to take a view of Chinese demand prospects than Chinese players themselves?
Except that, as Macquarie Bank counters, the proliferation of short positioning across contracts such as aluminum, previously shunned by Chinese investor players, may suggest something else is going on as well.
“Many of the named entities that have increased shorts on SHFE through this period are organizations that cater to retail investors as well as institutional clients,” it notes, adding that as such “crowd momentum will be stronger, but wallets will of course be shallower.” (‘Chinese funds find direction - down again’, Nov. 13, 2015).
The inference is prices might be more volatile for a longer period of time than in previous Chinese bear attacks.
What is not in doubt, though, is that there is an awful lot of money betting on lower metals prices and that it is primarily Chinese money.
If January was an early sign that Chinese investors could exert real influence on copper pricing, the current price action is proof that it wasn’t a one-off.
Editing by Susan Thomas