The copper short squeeze is happening - Morgan Stanley

Hopefully, you’ve been enjoying our analysis on this hot investment theme since I called the start of this latest run all the way back on March 14 on X/Twitter and in ChartWatch in our Evening Wrap. Be sure to also check out my April 9 article: Everything you need to know about every ASX copper producer.

Since the March low, it’s been nearly a straight line up to record highs on the London Metals Exchange (LME) and the COMEX exchange in the USA. Aussie copper stocks have followed, with many sporting 30-40% gains this year.

High grade copper price COMEX, including Carl’s technical factors. Source: Market Index and TradingView

Regardless of whether you were first to the copper party, or you’re only just thinking about getting involved today, the big question is how much further does copper have to run?

With respect to the technicals, make sure you stay tuned to ChartWatch in the Evening Wrap where I provide regular updates. As for the fundamentals, a research report released yesterday by Morgan Stanley has provided some important clues.

Squeeeeeze those shorts…

Morgan Stanley believes copper is currently in the midst of a “short squeeze”. A short squeeze occurs when traders who have either borrowed copper and sold it with a view to buying it back at a cheaper price, or who have used derivatives to simulate such a trade, scramble to exit their positions to avoid further losses stemming from the rising copper price.

Put simply, shorts aim to make money from a falling copper price so they lose when it rises. Sometimes, if market conditions are right, efforts by the shorts to limit their losses can result in the buying of more copper which can push the copper price even higher (triggering even more shorts to exit, etc.).

In this way, a short squeeze can result in a runaway price appreciation – like we saw with the infamous GameStop fiasco in 2021

According to Morgan Stanley, the copper short squeeze is taking place right now because “good fundamentals”, i.e., strong copper demand, is combining with positioning factors and a tighter market. The result is that many funds have been caught short by copper’s rapid appreciation, and there simply isn’t enough supply of the metal around to match the buying required for near-record short positions.

Supply + Demand = Shenanigans!

Starting with copper supply, Morgan Stanley notes that there has been “little progress on resolving supply challenges”. Exacerbating the situation, inventories available for delivery are extremely low. "Only 17% metal in LME warehouses is from a country which has brands approved for COMEX delivery", notes Morgan Stanley.

So, it’s not that there isn’t copper currently sitting in warehouses – simply that much of it is Russian in origin, and due to recent sanctions, it cannot be used for deliveries through either the LME or COMEX (i.e., two of the three major global metals exchanges).

Russian and Chinese metal makes up a growing share of the total LME inventory. Source: Morgan Stanley Research, LME

In terms of demand, there are two key factors at play – one in particular that’s feeding the current short squeeze. Firstly, the aforementioned positive fundamentals are driving steady demand for physical copper. I have to give Morgan Stanley credit here because as they point out in their research note, they were very early with their bullish copper call based upon these fundamentals.

But, there is another element of demand that is more of a quirk of the current trading environment  and due to the positioning of major hedge funds. Some hedge funds have tried to arbitrage across the various exchanges where copper pricing differentials have arisen. The biggest price premium has occurred on COMEX, causing many funds to short copper there while simultaneously going long in other markets.

The goal of these funds is to physically transfer copper into the USA to meet their short obligations. In theory, these trades are worked out in advance to come out profitable for the hedge fund regardless of moves in the copper price across the markets being arbitraged. But it appears that some funds miscalculated their ability to transfer copper into the US given that both Russian and Chinese metal cannot be delivered to COMEX.

Most of the copper on the LME is not from countries that have brands deliverable to COMEX, making wide differentials harder to resolve. Source: Morgan Stanley Research, LME

Worse still, the scramble for shipping to facilitate these trades has caused severe tightness in that market as well, and it appears many funds are destined to miss the deadline for the July futures contract’s delivery. 

As a result, these funds are being forced into the futures market to purchase the necessary contracts to cover their exposure. Translation: the sum of all these shenanigans is pushing the copper price higher.

COMEX Copper longs are at a record but shorts are also not far off all-time highs. Source: Morgan Stanley Research, COMEX. Source: Morgan Stanley Research, COMEX

How high can the copper price go from here?

Morgan Stanley has maintained a long-standing “base case” target for copper for 2024 of US$10,500/t for the LME. You can see from the chart below that they’ve been spot on with their call given the last traded LME copper price is US$10,587.

LME copper chart

Morgan Stanley chose not to update their base case target in this latest research report, but they did make note that their “bull case” target is US$13,125. This implies a further 24% upside from the current copper price if achieved.

The broker’s closing statement says it all: “While last week's rapid price moves may be followed by volatility, we continue to see positive fundamentals and upside ahead for copper”.