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August 25, 2006

Tactical Copper Trends
by Adam Hamilton

Copper, a lowly industrial metal seemingly incapable of capturing investors' imaginations, has become the dark horse champion of our unfolding commodities bull. It just keeps rising and rising on balance, becoming the little engine that could.

Copper is not precious, you will never hear of investors eagerly hoarding it like a true precious metal. Yet its bull-to-date performance has utterly trounced the precious metals coveted all throughout history. As of all their respective bull highs this past May, copper was up 3.1x more than gold, 2.3x more than silver, and 2.6x more than platinum!

With breathtaking performance like this, copper should be the belle of the metals ball. In a true market meritocracy, copper would certainly be the superstar metal. Copper-centric websites would be multiplying like rabbits, copper stories would be gaining increasing traction on CNBC, and average investors would be growing aware that copper prices are thriving.

Yet copper still gets little respect, even amongst commodities-focused investors. Gold and silver stocks are trading at stratospheric valuations today, investors can't buy enough of them despite their persistent inability to earn anywhere close to the levels of profits necessary to justify their rich stock prices. Meanwhile copper stocks, which have also done extraordinarily well, are trading at dismal bear-market valuations today.

How is this possible? How is a mundane everyday metal blowing the precious metals out of the water in performance terms? Copper's global supply and demand profile, which is purely industrial, has been and remains tremendously bullish. Copper is one of the most fascinating sub-bulls in our current great commodities bull.

Global demand for copper is rising rapidly, primarily because of the enormous amounts of this key metal required in the industrialization of Asia. Yet global supplies remain constrained. Copper prices were so low for so long that few incentives existed for miners to keep exploring for new copper projects. And even with miners scrambling to bring new copper mines online today, it will take many years for supply to catch up with surging demand.

Due to these factors copper, an unassuming and dull metal ignored by almost everyone for many years, has become a standout performer. Copper's stunning advance was generally not anticipated because there is no precedent for it. During the last great commodities bull in the 1970s, Asia was not industrializing. Back then copper only rose modestly, to a tiny fraction of the bull-market gains achieved by gold and silver.

Today copper is an amazing testament to the raw power of the free markets and the laws of supply and demand. Despite copper not being an investment metal and therefore usually being ignored by the vast majority of investors, it has surged to the forefront of the metals bulls.

The really exciting and crazy thing about all this is it is still not yet widely known! Copper stocks are generally tremendous bargains today in valuation terms, almost as cheap as oil stocks. Since the thundering herd hasn't caught wind of the whole wild copper scene yet, vast opportunities still exist in copper stocks. But in order to uncover the most opportune times to trade these thriving stocks, we have to gain a solid understanding of the technical behavior of copper itself.

Just as the bull market in this pure industrial metal with no investment cachet has been totally unique, so are its resulting technicals. Copper has done wondrous things in the last few years that I have never seen anywhere else, its fundamentals so strong that it has defied typical market behavior. It is utterly fascinating!

Copper's magnificent bull market since late 2001, in which it has rocketed an unbelievable 575% higher as of this past May, has had two distinct stages. There was the pre-parabola stage running into late 2005 and then the parabola stage running for the past year. To best analyze copper technicals, we really need to look at these two distinct stages individually. Somewhat surprisingly, they do bear much in common upon close examination.

This initial chart shows the strategic overview of the entire copper bull to date, which has clearly shot parabolic in 2006. The two shaded areas highlight the specific sections of the copper bull covered by the following two charts. The red line is relative copper, or copper divided by its 200-day moving average. Copper's bull, especially since 2003, has been extraordinary in a multitude of ways.

While you'd be hard-pressed to find a more extreme example of a commodity price going parabolic, copper has exhibited a stubborn resiliency that greatly reduces the odds it will crash. Although crashes are the normal expected aftermath after major parabolic ascents, copper has defied the odds twice now. Instead of swiftly collapsing back down to its 200dma after parabolic tops, copper has instead just nonchalantly consolidated sideways.

Note above that since its bull began copper has spent virtually no time under its 200dma. The red rCopper line barely ever hits 1.00 relative. No matter how fast copper has been rising, no matter how steep its upslope becomes, copper steadfastly refuses to fall hard and fast. Rather than rapidly returning to its 200dma as is typical in these situations, copper just casually wanders forward in high consolidations and forces its 200dma to rise to catch up with it.

Interestingly the late 2003/early 2004 copper upleg, the first of its bull market really, was considered a parabolic ascent at the time. While it looks small now in comparison thanks to our latest massive parabola, at the time it was enormous and considered highly unsustainable. Yet copper defied popular predictions of doom at the time and consolidated into the future rather than crashing down sharply.

A couple years ago I did some parabolic analysis on the HUI gold-stock index. At the time one of my goals was to somehow measure parabolic slopes, in order to empirically quantify just how extreme a particular parabola was relative to its peers. I hoped to use this data to more accurately time my gold-stock trades. Unfortunately continuously changing slope gradients are complex to calculate.

Despite people graciously writing in and trying to help me with this exercise, I couldn't find a parabolic measure I liked. While studying copper parabolas this week though, a simple new idea came to mind. Rather than worrying about slopes and by extension the calculus necessary to define them mathematically, why not just create a simple slope proxy that everyone can understand and replicate?

One way to do this is quite easy, yet still empirical. All we have to do is isolate the final euphoric vertical ascent of any parabola. Then we determine the percentage gain in the parabola from its starting point to its ultimate apex. This final-stage gain is then divided by the number of trading days this final ascent took. The resulting metric expresses the extremeness of a particular parabola in terms of its average percentage gain per day in its final rocketing blowoff phase.

This proxy for parabolic extremeness is used in both charts below to compare the 2003/2004 parabola with our latest specimen of 2006. It is probably hard to believe after the stunning copper parabola of 2006, but the 2003/2004 copper surge was considered at the time to be an unsustainable parabola, a one-time anomaly due to Chinese demand and particular supply disruptions.

The copper bull market started without fanfare in late 2001, and gradually marched higher in an initial modest uptrend for the next couple years. As you probably recall, back in 2002 and 2003 gold was the primary commodities bull capturing traders' imaginations. Gold gradually broke above $300, $325, $350, and $375 over this period of time and gold stocks were skyrocketing. Copper was ignored, yet it continued higher anyway in its stealth bull.

By late 2003 copper broke out of its initial modest uptrend and started climbing rapidly higher. Insatiable demand out of China, at high levels the industry had not expected, led to the rapid depletion of above-ground copper inventories. As inventories plunged, copper prices climbed relentlessly. In October 2003 this demand-driven rally went parabolic on news that a lethal rockslide slowed production at the third largest copper mine in the world in Indonesia. It was the perfect storm at the time.

In its final parabolic ascent marked above by the blue arrowheads, copper soared 58% over 67 trading days, or just under 0.9% per day on average. This totally crazy spike higher, the largest and steepest in nearly two decades, sure looked unsustainable at the time. It had blasted rCopper up to 1.527x copper's 200dma and most folks at the time, including me, figured copper would probably fall rapidly as the supply disruptions ended.

But amazingly it didn't! Global copper demand remained strong and supplies could not keep up, so copper did something that is almost never seen off of parabolic tops. Rather than crashing lower, copper started trading sideways in a peculiar peak consolidation. It was a strange event, seemingly telegraphing to the world that copper's multi-decade nominal highs were fundamentally driven, not just speculative anomalies.

After a couple months largely oscillating between $1.30 to $1.40 per pound, copper finally retreated modestly. But instead of correcting to its 200dma as bulls are wont to do, it soon started trending higher in a high consolidation. This event was wild and totally unexpected. Copper demand was so strong worldwide relative to supply that it just couldn't crash or correct hard like a normal bull.

Copper's high consolidation continued into mid-2004. It was climbing on balance and forcing its 200dma to rise to play catch up. Incredibly, in less than three quarters after copper's early March 2004 parabolic top, it was already carving fresh new bull-to-date highs! Just after this surge to new highs in early October, copper finally corrected a bit and kissed its 200dma briefly.

Thus copper took its sweet time, about eight months, to revisit its 200dma after its parabolic top. There was no crash and not really any meaningful correction. Copper had simply rocketed up in a parabola and plateaued, which is not the expected response after a parabola unfolds. I believe that this was only possible because global copper demand was growing far faster than copper supply so fundamentals overwhelmed any skittish speculators selling ahead of the expected sharp correction.

And even copper's plateauing behavior was unique. Check out the red rCopper line above. For much of 2004 and 2005 copper traded in a fairly fixed consolidation range above its 200dma. While copper's 200dma was running inexorably higher and trying to catch up with the manic metal, copper kept on rising out in front of it. Despite its relatively tiny following among speculators compared to gold or oil, fundamentals kept driving it relentlessly higher on balance. Copper broke out of this new uptrend in late 2005.

This yields some interesting trading observations. Since 2003, copper has only approached its 200dma four times. Three of these times were exceedingly brief too, a matter of days where copper flirted with its 200dma. If copper continues this behavior into the future, which is entirely possible given its continuing structural deficit worldwide, traders cannot wait for conventional 200dma pullbacks to buy copper or copper stocks.

Per the chart above, anytime rCopper slides under 1.08x or so copper is probably a good buy technically. In light of this precedent, I think we need to look at throwing long copper and/or elite copper-mining stocks whenever copper retreats within 8% of its 200dma. In terms of conventional bull analysis this is a very high buy zone relative to a 200dma, but copper has proven that it is no ordinary bull.

Its purely industrial supply/demand profile largely untainted by speculative emotion-driven buying and selling has led copper to keep marching higher on balance regardless of technical norms. Interestingly this extraordinary behavior we witnessed from 2002 to 2005 has continued in copper's latest mighty parabola of 2006. Like an air bubble under water, copper just seems to want to naturally rise. Apparently you can't keep a good metal down.

These charts overlap slightly, so we'll start the next step of our technical journey in August 2005. Copper was near its upper resistance rendered on the previous chart and was threatening to break out. Its first attempt failed though so speculators sold, leading to a modest pullback that took it to 1.082x relative, nearly within 8% of its 200dma. This was the best buying opportunity in copper last autumn, and it only lasted a few days.

Copper then continued higher in a strong but reasonable uptrend. From its September lows to early February the oft-ignored base metal climbed 40% to new all-time nominal highs up above $2.30. Copper then started trading sideways for the next six weeks in what looked like an apparent topping consolidation. This is where things get a bit tricky and correlation analysis comes into play. The correlation I am interested in is between copper and gold.

Gold topped February 2nd at $572 while copper topped February 6th at $2.34. At the time these looked like the real interim tops. Gold would trade sideways for the next couple months, not closing above its early February highs until the very end of March. Copper largely did the same, not seeing closes above $2.34 until late in March, about 8 trading days before gold's own new bull highs were achieved. Due to this sideways action in both metals, they appeared to be consolidating after topping.

But in late March gold started moving again, and the whole metals complex including copper sparked to life in sympathy. I believe the reason gold started soaring in its own parabola was because the dollar started sliding in late March ahead of gold's renewed vigor. For our Zeal Intelligence subscribers, I discussed this thesis in depth in the June 2006 ZI, looking at gold, the dollar, silver, copper, and the HUI technically. Gold appeared to be the ringleader.

With gold moving, copper followed as metals speculators poured into it. The resulting final ascent marked above saw copper rocket up 86% in just 45 trading days, a staggering 1.9% per day average parabolic pace! Copper advanced so fast that it ultimately reached 1.841x its 200dma on May 11th, incidentally the very day gold and silver topped, before it started retreating. If there was ever a time for a copper crash, this was it.

If you look at the charts and/or read the 6/06 ZI, it is pretty evident that copper was pretty tightly correlated with gold leading up to the May 11th interim highs. After May 11th both gold and silver started falling sharply. If copper was playing gold's game, it should have done the same. Yet instead of following in a steep slide, copper started consolidating sideways in another peak consolidation similar to 2003/2004. It was incredible.

Copper, which had just shot vertical into an incredibly aggressive parabola as the first chart showed, once again reasserted its behavior of ignoring the high odds for a crash and instead nonchalantly loitered around its all-time highs. Such a sharp move suggests copper's stunning parabolic ascent had to be partially speculator-driven, but despite this copper supply and demand was bullish enough to let it hover near highs while gold fell. So during this peak consolidation in May copper was once again decoupled from gold.

Then June rolled around, and gold abruptly plummeted down to its 200dma. Copper fell in sympathy but to a much more modest degree. Copper reasserted its curious independence from normal technical probabilities and bounced at 1.28x above its 200dma in June, very high for an interim bottom. Then it climbed higher and has since entered another high consolidation, although this one is trending lower at the moment just like gold's. Copper has since meandered around $3.50, levels that would have seemed absurd six months ago, as if they were nothing.

These recent competing crosscurrents in copper are fascinating. Some of the time copper behaves like it has in previous years, generally rising on balance and seemingly incapable of sharp falls. After any copper rally, no matter how steep or technically crazy, copper just hangs out at its dazzling new highs casually. And then it gradually meanders sideways, in no hurry, and forces its 200dma to rise to catch up with it rather than the usual process of a 200dma dragging down a price after a high.

But there have also been other times in the last six months when copper seems to be held hostage by gold. Wherever investors and speculators drive the gold price, copper follows like a lost puppy. But copper's upward tendencies still shine through here to some degree too. It tends to far outperform gold during both up episodes and down episodes, climbing higher than gold in the former and falling less than gold in the latter.

Why do I bring up this crosstalk between copper and gold? It creates two different trading scenarios in the near future depending on whether copper follows gold or not.

Gold and silver, like it or not, are consolidating after their parallel May bull-to-date highs. As I discussed extensively in the current August Zeal Intelligence for our subscribers, the HUI is in the same boat. There is a good chance the June lows in gold, silver, and the HUI will be challenged again. If this happens, and if copper follows gold lower, then we may get a copper-stock buying opportunity sooner rather than later. There is a lot of recent technical precedent for copper mirroring gold in the past six months.

Conversely if copper reasserts its independence and its wonderfully carefree rising-on-balance behavior continues, it could continue to drift sideways to higher. Such a high consolidation would make traders around the world comfortable with copper's new high levels and lay the foundation for the next major copper upleg. There is plenty of evidence copper may do just this, act independently of the precious metals as it has done so many times in recent years.

So which scenario will play out? I don't know. Personally I would prefer copper to approach its 200dma sooner rather than later, probably via sliding with gold, so the next great copper-stock buying opportunity happens soon. Once copper gets within 8% of its 200dma, we should be good to go on the buying front.

All summer at Zeal we have been doing comprehensive fundamental research on base-metals stocks to find our favorites. Half of these are elite copper plays, into which we are really excited to deploy when the copper technicals look highly favorable once again. We are planning on publishing our latest extensive base-metals stock fundamental research in a new Zeal Report in the coming week or two.

Once copper technicals are highly favorable again, regardless of whether it is sooner or later, we will launch our next campaign in elite copper stocks in our acclaimed monthly Zeal Intelligence newsletter. If you want to see which copper stocks we are buying and when, fundamentally cheap companies that are likely to thrive as the bull market in copper continues, then please subscribe today so you don't miss the coming opportunities.

Our subscribers also have access to various private copper charts on our website, including a large rCopper one that I use myself at Zeal to monitor copper's progress. You can monitor the same charts we do to watch for the coming buying opportunities in copper stocks.

The bottom line is copper's mighty bull has been unique among the major metals. Copper demand growth is so far ahead of copper supply growth that its price seems to want to rise on balance regardless of how crazy it gets technically. And the industrialization of Asia, which is driving the stunning marginal copper demand, is just beginning. It will probably take miners many years to catch up and bring new copper mines online.

Astute investors and speculators can take advantage of this powerful bull, which surprisingly remains not widely known. Most elite copper stocks are trading at extremely low bear-market-types of valuations, so they are ideal for long-term value investors too. Even if copper was to trade sideways for years to come, with no new highs, copper stocks would still have to almost double from here to merely hit fair value!

Adam Hamilton, CPA
Zeal LLC.com

Do you enjoy these essays? Please help support Zeal Research by subscribing to Zeal Intelligence today! &www.zealllc.com/subscribe.htm

If you have questions I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/financial.htm for more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I WILL read all messages though, and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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