Behind The Copper ETN’s Impressive Rally

by on October 18, 2010 | ETFs Mentioned:

While many commodities have surged higher in recent weeks, a few have stood out as some of the biggest beneficiaries of a suddenly weak dollar and resurgent global economy. Prices of corn and sugar have jumped significantly higher thanks to supply issues, while silver and gold have surged as investors lose confidence in paper currencies and brace for actions that could spur a rise in inflation at some point down the road. However, many important commodities in the industrial metal sector have outpaced these large gains even as as enormous gains in the nickel, zinc, and copper markets haven’t received nearly as much attention as rallies in precious metals and agriculture.

In fact, most products in the Metals ETFdb Category have failed to attract significant amounts of assets; seven of the nine funds have less than $75 million under management. Yet despite this lack of interest, many of the funds in this category have surged ahead and have produced solid gains for investors. A great example of this is the exchange-traded note offering exposure to copper. The iPath Dow Jones-UBS Copper ETN (JJC) has skyrocketed by an impressive 30% over the past 13 weeks, making it one of the best performing commodity ETPs over the time period. Going forward, it doesn’t hurt that the copper futures markets are currently flat, suggesting that the fund may be able to avoid the often devastating impact of contango for the foreseeable future. However, this fund has managed to outclass many of its peers in the category on another measure as well; it is one of the more liquid base metal commodity funds on the market with average daily volume of just over 110,000 shares. Due to the fund’s dynamic combination of liquidity and return, we have highlighted three key reasons for JJC’s rise and why the increasingly popular ETN could be headed for new heights in the coming months [see The Definitive Guide To Copper ETFs].

Rising Demand

Although growth may be non-existent in much of the developed world, many large emerging markets–such as India, China, and Indonesia–are all seeing growth rates above 8% and are continuing to demand large quantities of these industrial materials in order to continue to power their rapidly growing economies. “China remains the main driver of demand for metals,” Commerzbank AG said in a research note. The bank went on to predict “imports at a relatively high level in the coming months,” citing capacity reductions stemming from steps taken by the Chinese government to save energy. Thanks to these new measures in China and robust growth in other emerging markets, demand for copper could continue higher as industrialization increases at an unprecedented pace in the developing world [Looking For Industrial Powerhouses? Try These Three Country ETFs].

Low Supply

Thanks to this quickly rising demand, inventory of the metal has been rapidly depleting over the past few months. Stocks on the London Metal Exchange of the red metal have plunged by more than 100,000 tons over the past three months, which suggests that current output is not enough to take care of demand. However, some believe that this is just the beginning of the trend and that soon the entire copper reserves will be depleted. “The combination of lower copper-exchange inventories, robust demand largely driven by emerging-market urbanization and a constrained copper-supply outlook will sustain copper deficits large enough to mostly deplete exchange inventories by the end of 2011,” Goldman Sachs Group Inc. analysts led by Allison Nathan and Jeffrey Currie wrote in a note to clients last week, suggesting that the copper bull market could just be beginning [see Inside Five Surging Commodity ETFs].

Weak Dollar

Arguably the biggest reason for JJC’s surge has been an increasingly weak dollar. Investors are rapidly losing faith in the American economy’s ability to transition back to solid growth levels and create jobs, and a new quantitative easing program from the Fed looks to add to these concerns and put added pressure on the greenback. Over the past three months, the U.S. dollar index has fallen by close to 8% and since copper–like virtually all commodities–is traded in dollars, a decrease in value for the greenback generally leads to a rise in commodity prices. If the dollar continues its slide, it could be the ultimate bull case for the industrial metal going forward [see The Definitive Short Dollar ETF Guide].

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Disclosure: No positions at time of writing, photo is courtesy of Daniel Schwen.