Copper's Gain, Risk On (JJC, CU, COPX, FCX)

Today’s surprise report on the increase in housing starts has put some added energy into copper futures, which have been holding more or less steady this month following a rise of about 2% late in June. The red metal has added almost another 2% so far today.

Copper ETFs are also getting a boost. At about mid-morning, the iPath DJ-UBS Copper Total Return Sub-Index ETN (NYSE: JJC) is up about 1.9%, the First Trust ISE Global Copper Index (NYSE: CU) is up more than 2.5%, and the Global X Copper Miners ETF (NYSE: COPX) is also up more than 2.5%. The world’s largest publicly traded copper miner, Freeport-McMoran Copper & Gold (NYSE: FCX) has gained more than 1.5%.

The better news on the housing front could be a sign that the US construction industry has turned a corner, and that this is just the beginning of an upward trend in housing construction.  Perhaps just as likely is that it’s an anomaly and the state of new housing starts will return to previous levels in next month’s report.

New construction is critical to demand for copper, and if the implied US demand for copper is encouraging, there is even more encouragement for higher copper prices coming from China. In Shanghai, the price of copper has topped $5/pound, but there is increasing reluctance among buyers to pay the current prices.

The copper supply shortfall forecast for 2011 remains in place, and China, which consumes about 40% of the world’s supply, drives the metal’s price moves. The country’s inflation rate reached an annualized rate of 6.4% in June, and the government’s efforts to slow it down have been only partially successful. Many of China’s local and provincial governments have been able to continue housing construction.

However, many of the units being built are not affordable to the average Chinese family. There is a two-tier system of housing construction in the country. At the higher level are middle- and upper-income Chinese who can afford to play in the country’s high-octane real estate market. At a lower level are those who need government support to afford a place to live.

The first group has done well, but the second group has not had much attention paid to it until just recently. The government recognizes that it has to change that in order to ensure domestic peace. Inflation coupled with high prices for food, housing, and consumer goods make for a restless population. China cannot afford that.

As a result, construction of lower-priced housing is very likely to continue, even though it flies in the face of other steps the government is taking to cool inflation and growth. That means that later this year, copper prices will rise again.

China’s copper market has just exited a backwardated market, where current prices are higher than futures prices. The difference is still slight, but as the spread widens, copper demand will pick up. And if the latest report on US housing starts is reinforced by next month’s numbers, copper could head bust a new all-time high of more than $4.70/pound in London.

Paul Ausick