Morgan Stanley: A perfect storm for copper

Here are the key takeaways from major broker Morgan Stanley’s latest “metal&Rock” research update released yesterday. In the opening section titled "Copper’s Ascent”, they note that copper remains their “top pick” in base metals. Further, Morgan Stanley believes the narrative around copper’s fundamentals, as well as its recent price appreciation, are both still “gathering momentum”.

Supply versus demand

Morgan Stanley notes that “supply issues have accelerated”, and this means the broker now expects a 700kt deficit for the red metal in 2024. This has pushed them to increase their forecast for the copper price up 12% to US$10,500/t by the fourth quarter of 2024. Copper closed at US$9,300/t on the London Metals Exchange yesterday, so this implies a 13% increase in the copper price by the end of the year.

The main driver of the expected increase in prices is the supply side continues to be plagued by disruptions from weather and power generation. Morgan Stanley now estimates that mined copper output will be 0.7% lower this year. Supplies of refined copper are also likely to be subdued in the short term due to a cut back in production at Chinese smelters.

Mine supply disruptions have been accelerating. Source: Company guidance, Morgan Stanley Research

On the demand-side, Morgan Stanley notes that demand is “holding” due to a combination of increased demand from the data centre and the AI industry.

China, in particular, is also hoovering up copper. Refined imports into China were 27% higher in the January to February period compared to a year earlier. Motor vehicles (30% in exports), washing machines (40% increase in exports), and air conditioning (17% increase in exports) are all applications stoking demand for the metal.

China apparent demand is up 18% YoY on average in the last 5 months. Source: Bloomberg, Morgan Stanley Research

A crowded trade?

There are some risks in the long copper trade, though, suggests Morgan Stanley. The main point of contention for copper bulls is that Chinese copper inventories are yet to “roll” from seasonally high levels. To translate, yes China has hoovered up a great deal of copper, but the market wants to see it use it to make more cars, washing machines, and air conditioners soon, or it will signal purchases have not been in step with underlying demand in the global economy.

China copper inventories are taking longer to roll over than normal. Source: Bloomberg

The chart above shows that 2024 copper inventories, whilst the lowest since 2018, are still building at a time when they had already started to be consumed in 2022 and 2023. The move is not inconsistent with prior years, which took up to a couple months longer to roll, though.

The other major issue for copper bulls, is that ironically, just about everyone is already a copper bull! Morgan Stanley notes that COMEX Copper positioning has “risen sharply”, with net positioning rising to over 2-year highs. There’s plenty of interest in the copper trade both ways, notes the broker, as there’s been a spike in both long and short positions.

COMEX Copper positioning has risen sharply but does not look overstretched with both longs and shorts elevated. Source: Bloomberg, Morgan Stanley Research

Another sign the copper trade is growing crowded, according to Morgan Stanley, is a large and widening call skew. Translated, this just means investors are paying relatively more and more for call options (i.e., bullish bets on the copper price) compared to what they’re paying for put options (i.e., bearish bets on the copper price). This can be an indication the market is becoming irrationally exuberant.

Copper has flipped to call skew, reflecting increased demand for upside price expressions. Source: Bloomberg, Morgan Stanley Research. Based on 25DC versus 25DP

The theory behind the concept of a crowded trade is that if everyone has already bought into an idea, then who is left to buy? So, is copper a crowded trade? Morgan Stanley has considered the market dynamics of copper and concludes that whilst positioning is by its assessment is “elevated”, it isn’t yet “overstretched”.