Monday, April 18, 2011

More on ETFs and the Death of Dr. Copper

A recent wobble not withstanding, the charts on Dr. Copper still look pretty strong, with the barometer of economic growth staying above its 50-day moving average. Despite the choppiness this month, Copper is still up about 2.7% in November.

Looking forward the market fundamentals on copper also seem pretty strong, say commodities analysts with Bank of America Merrill Lynch, who note that stockpiles of copper on the London Metals Exchange have been falling and Chinese demand has been sturdy.

And then there’s the physical ETFs, which have been getting launched all over, as Wall Street tries to capitalize on the commodity’s surge. We’ve already mentioned how the physical ETFs might mark the death of Dr. Copper. BofAML analysts write:

On the copper market, where fundamentals are already very strong, we believe that inflows into ETFs could lead to a further tightening of the physical market. In turn, this would in all likelihood lead to sharp increases of spot prices and physical premia … Given the potential sharp increases in prices and premia on the back of the ETFs,?we are somewhat concerned over longer-term fundamentals for metals such as copper. An ETF-induced tightening of fundamentals would almost certainly increase the incentive for substitution, which could lead to a structural deterioration of fundamentals.

Translation: If demand from physical ETFs puffs up the prices of copper, to the point where it changes the behavior of the actual industries that use it — rather than speculators who just want to bet on it — that could mark the death knell for the metal as a barometer of industrial demand.

There has been some good blogofodder written recently?on the similarities between the boom in securitization, which ended so well, and what some have started calling ETF-ization. Over at see Barbarian Capital, they write:

The creation of ETFs brings in new money into the pond without improving the cash flows of the underlying assets. Your risk increases simply because the asset prices are now higher. But the higher prices might result in more interest, new share issuance or whole new ETFs. This might be creating a positive feedback loop.

Hear, hear. We’ve learned what happens when investors get further and further removed from the utilization of an actually asset, like say a house or a ton of copper. This is worrisome.

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