Over the years, China’s epic building boom and demand for raw materials led to a seemingly insatiable appetite for copper. Copper was so popular, that banks created financing vehicles that producers could use to borrow against their copper supplies held in storage. However, when it was found out that companies would often pledge the same inventories for multiple loans, regulators quickly cracked down on this form of financing, sending shockwaves through the industry. Since then, prices have continued to trend lower as the outlook for Chinese growth continues to stumble. However, what is more troubling is the recent decision by policymakers to let a state owned metals producers file for bankruptcy, a first for China. This could open the doors for a deluge of bankruptcies that hurts copper prices as they no longer receive the guaranteed support of the Chinese government.

Plagued By Overcapacity

During the long period of record low borrowing rates, commodities producers borrowed massively to invest in upgraded capacity and new operations designed to grow output. However, the investing binge ultimately has led to bust, with many producers forced to cut back on their production due to the ongoing supply overhang relative to demand.Producers in China have notoriously had an advantage thanks to generous state subsidies that have enabled the industry to remain hyper-competitive relative to global peers, adding to the surplus which is forecast to last until 2020.However, with economic activity decelerating rapidly, demand has failed to keep up with bursting supplies. To a large degree, higher prices witnessed earlier in the year were the function of state supported demand, thanks to the government buying 150,000 tons at the beginning of the year to bolster domestic producers.

Spare capacity across Chinese copper remains a huge problem that until now has gone unresolved. Now, thanks to the first bankruptcy of a state owned entity, the tides may be changing for state owned metals producers as they no longer are guaranteed a state sponsored backstop. The liquidation proceedings for Gaungxi Nonferrous Metals is the first shoe to drop in what could be a potential tsunami of state-owned company bankruptcies. As the country works to reduce industrial capacity in light of low commodity prices, the longstanding supply and demand imbalance may finally be alleviated. Additionally, with housing prices rising across the country at the fastest pace on record, demand may be supported in the meantime by residential building.However, if high prices should derail buying, copper may be destined to continue its plunge.

Technically Speaking

Since falling to the lowest levels since 2009 back at the beginning of the year, government buying and mine closures have been able to provide a small safety net for copper prices. However, if the state support dries up, prices may be set to continue falling despite the possibility of stronger demand and weaker supply fundamentals. From a technical perspective, copper prices are undergoing a period of consolidation, indicating that prices could be approaching a breakout that leads to continuation of the prevailing downward trend or a trend reversal to the upside. The symmetrical triangle setup indicates that trading the narrowing range forming between a downward trend line and an upward trend line may not be advantageous due to shrinking reward potential. However, a candlestick close above the downward trend line or below the upward trend line could be an early breakout signal.

Considering falling trading volumes and lower volatility, the signs of an impending breakout are becoming clearer with each passing session. However, outside of the consolidation, other indicators are adding to the sense that a major move is rapidly approaching. For one, the 50-day moving average is trending above prices, acting as resistance against any prolonged rally in prices. Adding to the thesis of potential for momentum lower is the stochastic oscillator which recently saw the %K line cross over the %D line to the downside, generating a bearish signal.However, this bearish bias is offset by 200-day moving average below the price action acting as support. Nevertheless, should it be crossed by copper price action, it could be an early sign that momentum to the downside is picking up, paving the way for copper to test January lows.

Looking Ahead

There are a number of factors that could impact copper prices over the near-term in both positive and negative ways. While China has been slow to deal with chronic overcapacity in key industries, such as copper production, the first bankruptcy proceedings of a state owned company could pave the way for further consolidation helping to reduce the glut that has kept downward pressure on prices. Second, increased building could provide the much needed support for demand to remain elevated over the medium-term. Should the central government decide to back off of purchases and extremely high housing prices deter buying and building, copper prices may be unfortunately destined to remain low. Furthermore, a raft of bankruptcies could see warehoused copper dumped on the open markets, driving prices significantly lower. Without a stable demand catalyst, copper prices on the verge of a breakout may be driven back towards 2016 lows.

Featured Image: Mining.com