A financial manipulation of the copper market is coming, through the creation of physically based copper ETFs later this year. Understanding how this works and how it will affect the commodity price can give us a hint on how to profit from this inevitable rise in the metal's price this year.
Commodity ETFs are a relatively new asset class and have been growing by leaps and bounds.
Two types of ETFs have emerged, trying to capture the price movement of underlying commodities: Those that use the futures markets and over-the-counter swaps to financially represent the changes in prices, and others that depend upon physical stockpiling to represent actual commodity holdings of the fund.
The method employed is a very simple choice. If a commodity is difficult to store, a fund manager is forced into the futures markets to replicate a physical holding, a method fraught with enormous problems of monthly rolls, OTC swaps as well as extra commissions and fees.
As I outline in my upcoming book, Oil's Endless Bid, due out from Wiley and Sons in March, these are not insignificant issues and make oil and gas ETFs perfectly awful investments for retail customers just looking to track the price of the underlying commodity.
For metals, however, the choice of physically buying and storing commodities is possible and avoids all of these problems. It is most simple with gold, one of the most dense and expensive metals. Gold requires little space for storage and has multiple and easy networks for both acquiring and selling the product with little slippage. The largest commodity ETF by far, the SPDR Gold Trust has a market cap of almost $60-billion (U.S.), represented by physical stockpiles held by the fund's manager JPMorgan, in London.
Stockpiling physical metals for ETFs may avoid the problems of engaging financially in the futures markets and avoid all regulatory efforts to limit them, but it does inevitably remove physical product from the market from those that need it and contributes to supply problems.
Indeed, investment in the GLD has undoubtedly diminished supply and has helped increase prices to jewelry manufacturers. How much the GLD has propped prices for gold in the last few years based on ever increasing shares and market cap is difficult to know, and admittedly on pure speculation, but I believe it has been worth a few hundred dollars an ounce at least.
Problems and Opportunities
Nowhere will this impact of metals ETFs have more of an effect than in copper, with one physically based fund already in existence, but two more planned for later this year.
The biggest is a joint product from JPMorgan and BlackRock, which is predicted to dwarf the product from ETF securities launched on Dec. 10.
The problem of copper ETFs, of course, is that while gold's desirability is almost exclusively cosmetic, copper is a base metal necessary for real industrial growth. In addition, copper has been labouring under a shortfall between supply and current demand that is expected to grow over the next two years. A survey of 19 copper analysts put 2011's shortfall between 100,000 tons and 850,000 tons and the potential additional removal of supply for stockpiling for funds will add enormous upwards pressure on the metal's price.
All of this points to a tremendous opportunity for investors to get in on this mostly unintended manipulation of future copper prices.
The market has been well aware of the implications of new ETFs for quite some time, as well as the "regular"' fundamental upwards pressure on prices from a perceived economic recovery and industrial rebound. Copper is already up more than 30 per cent in 2010, reaching a high of $4.45 (U.S.) just after the New Year.
There are already reports of stockpiling beginning to take place at JPMorgan, in advance of the rollout of its ETF, both to take advantage of a lighter price and also to insure a small profit for the fund managers that a rollout spike almost insures.
Top Stock Picks
But for investors, there are better ways to invest in copper than with trying to engage in the physical commodity - or even buying into these new physical ETFs.
I still believe that investors do better - much better - over the long run by investing in issues intended for investing - stocks - as opposed to indexes or even physically based ETFs.
For copper, the stocks that will serve as the best proxy for rising copper prices will be the copper mining stocks, including Freeport-McMoran and Southern Copper . Other miners like Newmont and Rio Tinto have exposure to other metals and will not deliver a direct proxy to copper, although they will undoubtedly participate in a copper rally.
With the upwards pressure of new ETFs, copper is more than likely to see a continued rise in 2011. Take advantage of this unintended manipulation of prices with mining stocks.
Dan Dicker is a senior contributor to TheStreet.com and has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser.
- Copper High Grade Front Month Futures$2.20-0.02(-0.68%)
- Crude Oil Front Month Futures$43.84+0.19(+0.44%)
- Henry Hub Natural Gas Front Month Futures$2.07-0.02(-0.96%)
- SPDR Gold Trust$122.960.00(0.00%)
- Freeport-McMoRan Inc$12.010.00(0.00%)
- Southern Copper Corp$28.910.00(0.00%)
- Newmont Mining Corp$33.830.00(0.00%)
- Rio Tinto PLC$31.420.00(0.00%)
- Updated May 3 6:27 AM EDT. Delayed by at least 15 minutes.