Let’s Get Physical (Copper)!

by Aaron Levitt | December 18, 2012 8:10 am

JPMorgan (NYSE:JPM[1]) looks like it’s finally near the end of a rocky road toward launching its physically backed copper exchange-traded fund.

The fund — which mimics popular ETFs like the SPDR Gold Shares (NYSE:GLD[2]) and iShares Silver Trust (NYSE:SLV[3]) — will store actual copper in warehouses for the benefit of investors, which has sparked plenty of opposition worried about the fund causing price spikes in copper.

But with several studies under its belt and a European twin to consider, the SEC finally has granted JPM permission[4] to begin the process of getting the fund to market.

For investors, it provides an interesting opportunity to add a physical metal tracker in the industrial sector to their portfolios.

Grinding Forward Since 2010

As inflationary and monetary pressures have grown, many investors have turned to physically backed precious-metals ETFs as a way to turn the tide of those issues. JPMorgan — along with fellow asset manager BlackRock (NYSE:BLK[5]) — sensed the opportunity to expand that concept into the base-metal world and pounced on drafted filings with the Securities and Exchange Commission for a physically backed copper fund.

In October, the SEC postponed the decision on whether to approve JPMorgan’s proposed fund to this December to create “sufficient time” to consider all the facts. The key complaint heard was that the fund would significantly disrupt the market for copper.

Unlike gold and silver, which by nature are “designed” to be held in vaults as a store of value, copper is strictly an industrial metal. Producers use it to create value-added goods — wiring, pipes, etc. — so almost all of its production ends up as something.

And therein lies the problem.

Originally, JPMorgan was looking to register 6.18 million shares — with each unit representing 1/100th of a metric ton of copper, that’s 61,800 metric tons represented — for its fund. While that 61,800 tons is only a tiny part of a 20 million ton annual global copper market, it would represent the single largest holding of physical copper in storage at 30%.

Opponents of the fund argue that there is not enough metal available outside the exchange networks for immediate delivery, as the rest is tied up in long-term contracts. With not enough copper available for immediate delivery worldwide, the fund could create an artificial price squeeze.

What’s more, the effects could be compounded if the JPMorgan fund grows in popularity or if the BlackRock fund comes to market. Opponents estimate that removal of up to 183,000 tons of copper (between the proposed JPM and BlackRock holdings) would have a “devastating” effect on the market. Combined, the funds would comprise 70% of the immediate available copper.

A consortium of U.S. copper fabricators[6] — including SouthWire and Encore Wire (NASDAQ:WIRE[7]), as well as commodity-focused hedge funds — have fought against the two ETFs. This campaign has included lawsuits, letters to the SEC and even petitioning Sen. Carl Levin to get involved. (Levin did weigh in, saying the funds would cause a boom-and-bust cycle in the copper market.)

JPMorgan and BlackRock pooh-pooh the idea of such a price squeeze, saying the fund’s total size would be small relative to the scale of the global copper market. Analysts agree, saying concerns that the funds will remove a significant chunk of copper from the market could be an exaggeration. ETF Securities already has a physically backed copper fund for sale in England and has only amassed investments representing just about 1,950 tons — that fund has had zero effect on the spot price of copper.

While the jury still is out on what effects the fund will have on prices, the commonsense answer is once you remove some supply of anything, prices generally go up as long as demand is there.

In the end, though, the SEC sided with JPMorgan — and that approval will be the benchmark for the BlackRock fund, as well as other physically backed aluminum funds currently in registration.

Should Investors Bite?

As we’ve stated before, copper is not gold nor silver — it doesn’t serve as a store of value. Therefore, investors can’t and shouldn’t think that the physically backed copper fund is anywhere in the same vein as the gold/silver ETFs. That means you shouldn’t buy the fund as a play on dollar debasement or a way to protect your wealth in case the world turns really, really south.

This fund actually should bounce around quite a bit as it reacts to every piece of global economic news that hits the headlines — they don’t call the metal Dr. Copper for nothing. So as play on rising global growth, it might be an interesting bet.

It certainly is a departure from futures-backed funds like the U.S. Copper Index Fund (NASDAQ:CPER[8]) or the iPath Dow Jones-UBS Copper Total Return Sub-Index ETN (NYSE:JJC[9]), an exchange-traded note. The JPMorgan fund should track spot prices better than both of those vehicles, which could give it an edge in attracting assets.

So while it might give producers the willies, JPM’s eventual new fund shouldn’t have a hard time finding a place in many portfolios.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  2. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  3. SLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLV
  4. SEC finally has granted JPM permission: http://finance.yahoo.com/news/sec-green-lights-jp-morgan-133051152.html
  5. BLK: http://studio-5.financialcontent.com/investplace/quote?Symbol=BLK
  6. consortium of U.S. copper fabricators: http://www.chicagotribune.com/business/sns-rt-us-jpm-fund-copperbre8bg0i8-20121217,0,3617150.story
  7. WIRE: http://studio-5.financialcontent.com/investplace/quote?Symbol=WIRE
  8. CPER: http://studio-5.financialcontent.com/investplace/quote?Symbol=CPER
  9. JJC: http://studio-5.financialcontent.com/investplace/quote?Symbol=JJC

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