Is copper really a base metal? Hardly. It’s one of the most important leading indicators of global growth and especially producer sentiment in emerging markets. That’s why the dour outlook from mining heavyweights in recent days is such a cause for concern. Rio Tinto (RIO), Cargill, and Codelco have all provided warnings about weakening demand as their customers seek to delay shipments. (FT)
My outlook on commodity demand and especially copper has shifted from positive to vaguely negative over the last several weeks, and we exited a bullish position in the iPath Dow Jones-UBS Copper Subindex Total Return ETN(JJC). Price action has been decisively bearish, with December copper futures closing Tuesday down 17% from their recent July highs.
The fundamental situation at the moment seems to be that demand is holding steady in Asia, but is moderating everywhere else. As China keeps popping up new empty metropolises, it will still need more iron and coal and copper, so diversified miners like BHP Billiton (BHP) and Vale (VALE) are probably better positioned than some of their peers.
But Freeport-McMoRan (FCX), for example, is a purer copper play. Never mind the gold mines: on a daily basis, the FCX one-year rolling correlation to JJC averages 0.80 – 0.95. FCX fell 4% on Tuesday and is trending steadily lower.
With copper prices down so much, is it too expensive to get bearish here? Not really: with 60-day historical volatility around 48%, November at the money options are priced at about the same implied volatility level. And the skew between November and January is very flat.
FCX: Volatility Skew. Source: Livevol.
(for a free, no-obligation trial, enter the code ‘condor’ when you check out)
Let’s put on a short-time spread to profit from large price swings in the short-term as the copper outlook remains uncertain. By buying the November puts, we get to own exposure to October earnings at reasonable prices. Our risk profile is like a long straddle, so we want FCX to stay volatile.
This article was originally posted at TheStreet’s Options Profits site; trade details are withheld for members there.