The US Securities and Exchange Commission (SEC) approved JPMorgan Chase & Company’s (NYSE:JPM) proposed copper exchange-traded fund (ETF) in December, shooting down arguments by opponents who fear that the fund will reduce physical copper stocks available for industrial use and are considering legal action.
It has been more than two years since JPMorgan first sought approval for the fund, and if all goes according to plan, trading in the fund’s shares could begin on the NYSE Arca exchange in the first quarter of this year.
The opposition is mainly based on the assumption that copper stored in warehouses for the purpose of backing exchange-traded shares would remove a significant amount of copper from the physical market, exacerbating existing shortages and as a result driving up prices and making copper susceptible to manipulation by speculators.
“It appears the commission categorically rejected all of the substantial evidence presented as to the catastrophic damage that the proposed (fund) could have for industrial users of copper,” Robert Bernstein of the law firm Eaton & Van Winkle said in a letter to the SEC, asking it to reverse its ruling, Reuters reported. Bernstein said that the consortium that he represents — US copper fabricators Southwire, Encore Wire (NASDAQ:WIRE), Luvata and Amrod, as well as hedge fund and copper trader Red Kite — hasn’t decided whether to take legal action against the SEC, “but we certainly laid the groundwork to do that.” The consortium has until February 18 to decide.
The copper ETF would consist of 6.18 million shares, backed by about 61,800 metric tons (MT) of copper held in warehouses, according to a NASDAQ article. Blackrock’s proposed iShares Copper Trust — an ETF that the SEC recently delayed ruling on until February 22 — would hold up to 121,200 MT of copper. In total, the two ETFs would reduce the amount of copper available for immediate delivery by about 34 percent, pushing up copper prices and increasing its volatility, according to opponents cited by the SEC in its December ruling.
The opponents believe that since copper is used in construction, consumer electronics and in the automotive industry, the overall economy could be harmed if that happens.
“Approval of this commodity-based security is a blow to American businesses and consumers that rely on copper for industrial machinery, plumbing, transportation, electric power generation and transmission, and electronics,” Michigan Democratic senator Carl Levin said in a statement in response to the SEC ruling.
Analysts at Australian bank Macquarie are also skeptical about the ETF, and have said that while the market expects a surplus of about 50,000 MT of copper this year, it could return to a “significant deficit” by 2016 to 2017 if JPMorgan’s ETF attracts about $500 million cumulatively every year — the value of about 62,000 MT, The Telegraph reported.
The opponents’ argument is valid if indeed financial investors with no intention of purchasing physical copper for consumption jump on JPMorgan’s ETF en masse, or if investors purchase shares in the ETF to hold them, rather than to trade them or exchange them for copper. In particular, US pension funds, whose only option for getting exposure to copper has been to buy shares in producer Freeport-McMoRan Copper & Gold (NYSE:FCX), could be attracted to the ETF. Typically they have a longer-term view and are more likely to hold ETF shares than to trade them.
Meanwhile, the SEC argues that copper held by the fund is redeemable three business days after purchasing shares, at which point it can be sold for cash, swapped or consumed; therefore, the amount of copper available to industrial users won’t “meaningfully change.” It said this additional venue for purchasing copper will improve competition in the market, and in its ruling cites JPMorgan as saying that the ETF will “track, rather than drive, copper prices.”
The SEC ruling also states that the opponents’ calculation of currently available copper for delivery doesn’t take stockpiles in China into account, noting that there is no evidence to support the notion that China won’t export copper as it currently consumes about 40 percent of the world’s copper and its demand for the metal remains relatively robust.
Finally, the SEC is skeptical that all of the 6.18 million shares in the ETF will be scooped up by buyers upon launch, requiring JPMorgan to acquire the full 61,800 MT of copper immediately. It said JPMorgan predicts the initial share offering will hold 9,893 MT of copper.
Still, Seeking Alpha contributor Stuart Burns said he has some sympathy with consumers fearful of the impact that physically backed products could have on the market.
“Financial involvement has distorted the aluminum market so badly that there are officially some 5 million tons and potentially twice that sitting isolated from the market,” Burns said. The resulting competition has created premiums on aluminum, “over and above the LME price,” he added.
It could be that the JPM XF Physical Copper Trust’s impact on the market will be dictated by how many investors are interested in participating, and whether their intention is to just sit on the shares or to consume the copper. If existing copper ETFs indicate how JPMorgan’s fund will do, opponents may be able to breathe more easily. ETF Securities’ copper fund currently has $29 million assets under management, equivalent to about 3,700 MT of copper at today’s prices, or, in the SEC’s words, it hasn’t “grown to a substantial size since its inception.”
“I’m not sure there’s a net positive demand that’s all of a sudden going to materialize because of the product,” David Goerz of HighMark Capital Management in San Francisco told Reuters. Another investor, Charles Gradante, whose Hennessy Group invests in commodity hedge funds, said he won’t invest until the market capitalization of the fund is up to $1 billion, suggesting that for now, investors who typically chase highly liquid investments may hold off, mitigating any impact the fund will have on physical copper stocks.
Securities Disclosure: I, Ragnhild Kjetland, hold no investment interest in any company mentioned in this article.
| Updated December 2015
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