VANCOUVER - After a two-year regulatory battle, JP Morgan has won approval from the Securities and Exchange Commission (SEC) to launch an investment vehicle that tracks the price of copper.
The product will be the first of its kind in North America and was granted SEC approval despite strong opposition from North American copper users, who say inviting speculation into the copper market will artificially inflate prices.
The investment vehicle will be an exchange traded fund (ETF) backed by an inventory of physical copper. ETFs are securities that track something else: an index such as the S&P 500, a commodity like copper, or a basket of assets like an index fund. Importantly, ETFs are made up of shares that trade on the market just like any other stock. As such, ETFs enable investors to speculate on the index or commodity behind the ETF by simply buying or selling shares of the fund.
It is that speculation that has copper users in North America worried. A group of such companies representing half of US copper fabrication capacity argue the product will result in a "substantial artificially induced rise in near-term copper prices." That, they say, will "wreak havoc" on the global economy.
The companies found support in Carl Levin, chairman of the US Senate subcommittee on investigations, who said the SEC's approval of the copper ETF was "a blow to American businesses and consumers." He believes the funds will "allow speculators to create a squeeze on the market" and as a result will "increase copper prices and volatility, and undermine market efforts to produce prices in response to supply and demand."
The SEC saw it differently. In approving JP Morgan's application to launch its copper ETF – a similar product from BlackRock iShares will likely follow – the SEC said it did not think copper-backed ETFs would impact prices, primarily because they will not disrupt the supply of copper available for immediate delivery.
Indeed, a copper ETF will not consume the metal but simply hold it. If the price of copper climbs, that copper stockpile will increase in value. Since the fund's shares essentially represent a stake in the copper inventory, its share price should rise – and fall – with the price of copper.
JP Morgan has suggested its fund would hold a maximum of 61,800 tonnes of copper cathode, equivalent to 27% of the copper held by the London Metal Exchange. BlackRock's ETF could hold as much as 121,200 tonnes, almost half of the LME's stockpile. From another perspective, fabricators say those joint ETF holdings of 183 000 tonnes would represent the majority of copper available in the US through exchange-bonded warehouses.
Those are maximum numbers; in all likelihood the funds will start by amassing much smaller holdings. For example, JP Morgan says it plans to start trading with just 10,185 tonnes. Furthermore, even if the EFTs maxed out their holdings the inventories would still be small relative to global annual production, which averages 20 million tonnes.
However, limiting the physical availability of copper in North America is just one way these EFTs could impact copper prices. Another is through pure market speculation – investors could bid up the price of copper by bidding up the ETF's share price.
The magnitude of that impact will only be known once the funds are established. In Europe, two ETFs backed by physical copper have been launched in the past 18 months and both have had only limited success. Bankers generally believe the products could be more successful in the United States, where large asset managers have fewer commodities investments available.
Some bankers disagree. Société Générale notes that large metal inventories incur high storage and insurance costs, which mean these copper-backed ETFs would have to gain 4 to 5% annually just to break even. Of course, the goal isn't to break even but to beat the returns offered by investment vehicles with similar levels of risk. If stock XYZ provides a basic 2% dividend return, a copper ETF would have to gain 6 or 7% to compete.
Facts aside, investors may well be interested in trying a copper ETF on for size after ten years of highly successful gold ETFs.
In the early 2000s the only way for the average investor to ride the rising price of gold was to buy gold mining stocks, just as the only way for investors today to play the price of copper is to buy copper miners. Then in late 2004 the SPDR Gold Trust ETF debuted, allowing investors to play the price of gold directly. Importantly, the gold ETF also offered an entry into the gold market unburdened by the operating, political, and hedging risks inherent in most mining stocks.
Investors flocked to the lower-risk gold EFT. Gold miners, which until then had loosely tracked the price of gold, were left in the dust.
If these new ETFs drive the price of copper higher, copper miners will profit in the long run. But if investors flock to the seemingly greener pastures of copper ETFs, share prices for copper explorers, developers, and miners will take a hit.
At this early stage, how that balance will play out is anyone's guess. In fact, the SEC's green light to JP Morgan answers one of the questions swirling around these copper ETFs – whether they will happen – but many more remain.
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