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Chart Of The Day: Why Copper's Sell-Off Is A Buying Opportunity

Published 12/06/2017, 10:01 AM
Updated 09/02/2020, 02:05 AM
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by Pinchas Cohen

Copper Selloff May Provide a Buying Opportunity

There are three reasons why equities are currently selling off, two of which are tech-related:

  1. Investors are profit-taking, rotating out of technology, a sector that has gained 31.33 percent YTD. That's a full 74 percent more than the 18.02 percent gain of the benchmark index, the S&P 500, after the technology sell-off.
  2. US corporate tax cuts are causing investors to rotate out of technology shares, the sector likely to benefit the least from tax reform, since the tech industry's average effective tax rate is already at 18.5 percent, lower than the proposed 20 percent corporate tax rate.
  3. An expected slowdown in the Chinese economy, the world’s biggest metal user, compounded by the cooling off of its infrastructure binge—including the halting of a subway project—has sent industrial metals into a free-fall, dragging down mining shares.

For this post, we'll focus solely on the last point. Commodity prices are considered a leading indicator for the health of the economy in general, as they point to the trajectory of demand for the cornerstone of what infrastructure is built off of. This becomes more poignant when considering the persistence of low inflation since last year, an integral indicator of where the cost of goods is headed, which includes commodities.

Yesterday’s industrial metal decline was led by copper, which fell 3.4 percent in future contracts and 4.6 percent in the spot market. The selloff was spurred by a failure by smelters and miners to agree on processing fees for next year.

While this may be a specific fundamental cause that affects copper alone, it potentially forms technical momentum, as sentiment – already bearish on industrial metals – is compounded on the declining price of copper.

Copper Futures Daily Chart

Nevertheless, while the price of copper has been falling in the short-term since October 17, it has been in an uptrend in the long-term since January 13, 2016. As of October 2016 it has been trading within a rising channel.

Supply and Demand vs Momentum-RSI

This pattern is formed by two parallel, ascending lines. The bottom line is the uptrend, the “support line,” and the channel-bottom, while the top is the “resistance line,” or channel-top. The bottom line is formed by the lows after a fall from the top line, which is shaped by the highs. The lows, after a fall from the top line, are formed when demand shoots the price back up, toward the top line, while the highs are take shape when supply sends the price back down toward the bottom line.

While each force is dominated by its own line, the demand line is the stronger one, as it sets the tone, forcing the supply line to rise along with it. It is the graphic expression of demand overcoming supply. Still, the sellers agree with the buyers that prices should rise. It is understandable that buyers are willing to buy at ever higher prices since they must meet the prices of willing sellers. The reason sellers too are willing to sell only at higher prices is because they don’t believe a lower price is appropriate, implying that they too believe the price should be higher.

While the trend and peak-and-trough analysis suggest higher prices, the momentum-RSI, a leading indicator by nature (by the fact that momentum drives price) provides another view.

First, it created a negative divergence with the price, when the price peaks climbed between the September, 3.158 high and the October 16, 3.228 high, while the RSI declined in the same time, from 81.76 to 77.36. Since the momentum makes up the price, it often shows where the price is about to go. Sure enough, that’s when the current sell-off began.

Second, it created another negative divergence yesterday. While the low of 2.944 was still higher than the former, September 22 low of 2.875, the RSI registered lower than its previous low (one day after the price low of 38.13), at 34.47. This RSI downside breakout may suggest that the current price low too would register lower than the former trough.

Other than that, however, yesterday’s RSI read has been the most oversold since September 2016, a very bullish indicator indeed of a high potential for dip buyers.

Finally, the 200 dma (green) is tracing, as if guarding, the uptrend line/channel-bottom since October 2016.

Trading Strategies

Long Trade

Conservative traders would wait for confirmation that the long-term uptrend line overcomes the short-term falling channel, when it crosses above its top and finds support above it, with an up-day registering higher than the preceding down-day.

Moderate traders would wait for a full correction to the uptrend line and wait for confirmation of its integrity, with an up-day to cover the previous down-day.

Aggressive traders would wait for the price to fall closer to the uptrend line, for a better entry, providing a smaller whipsaw.

Targets:

  1. The channel bottom, at 2.990 per the current angle but falling each day
  2. The channel top, at 3.156 per the current angle and falling, while 3.100 provides resistance, as the last rally attempt was stopped short at that level, suggesting waiting supply
  3. 3.174, the November 24 high
  4. 3.228, the October 16 high, which needs to be overcome for the trend to maintain its bullish status

Stop-losses

When placing a stop-loss, consider both support/resistance (price levels which are expected to harbor supply/demand), as well as a minimum 1:3 risk-reward ratio, to employ a favorable statistical trade platform. Therefore, select minimum targets, relative to your entry and stop-loss to achieve the favorable risk-reward ratio.

Example 1: An entry at the current price of 2.974 provides a risk of 0.114, when placing a stop-loss below the uptrend line. The first target provides a reward of 0.020, establishing an unfavorable nearly 6:1 risk-reward ratio. That means that you’d need to win 6 times to come out even after a single loss. At this rate, you are sure to lose all your equity.

Example 2: An entry at 2.900 would provide a 0.040 risk, while the same first target would provide a 0.090 target, establishing a much better, but still insufficient 1:2.25 risk-reward ratio.

Example 3: An entry at 2.900, with the same stop-loss as the first example, but with the 3.228, October 16 high (fourth) target establishes a 1:5 risk-reward ratio.

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