Last week, we wrote about the crazy run-up and subsequent pullback in cocoa futures. Lately we have seen a parabolic rise occurring in copper futures. The price movement is similar, but to the best of my knowledge no one put an AI spin on cocoa’s move. The same can’t be said for copper.
This is quite a move, no? It may not be a meme stock, but this is a huge run by any normal standards:
Comex Copper Futures, Rolling Front Contract, 6-Months, Daily Candles
Source: Interactive Brokers
On a longer-term basis, the current move appears even more vertical, putting us in range of multi-year highs:
Comex Copper Futures, Rolling Front Contract, 5-Years, Daily Candles
Source: Interactive Brokers
It is always noteworthy when copper makes a big move. The commodity earned the nickname “Dr. Copper” because it has an uncanny ability to reflect supply and demand in the broader economy because of its multitude of industrial uses, including plumbing and electricity.
Since so many of those uses involve construction, copper’s run-up seems out of line with the economic numbers that we see. Housing starts in the US have not picked up dramatically, and China’s building boom has gone relatively silent. While the world’s industrial output is not in dire shape, it has not spiked higher recently. Why then the big move?
Some of it of course relates to specific factors of supply and demand in the futures market, but it is not difficult to imagine that some of the recent demand is related to the current AI-mania. The “tell” comes from the recent action in utilities stocks.
Utilities stocks are typically considered defensive. As a regulated industry, their growth tends to be limited, but their profits are stable, and they tend to have relatively high dividend payouts. In practice, they tend to underperform the broader market during bullish moves, but offer relative stability when markets sink. Their high payout ratio also makes them somewhat interest rate sensitive. What then explains the relatively vertical up move that we have seen in that sector’s benchmark ETF, the Utilities Select Sector SPDR (XLU) recently?
1-Year Chart, XLU (red/green candles), SPX (blue), 10-year Treasury Futures (purple)
Source: Interactive Brokers
We see that over the past month, utilities have acted neither defensively nor proportional to bond yields. XLU moved more or less in line with bond prices until about two months ago. Something changed. But while it is understandable that the sector underperformed the S&P 500 (SPX) as the major index rose toward all-time highs, the current move is much more than an overlooked sector playing catch-up. This too is about AI.
There have been numerous reports about how the widespread adoption of generative AI will create significant demand for electricity. The utilities would of course be the ones to supply it – hence the excitement about those stocks. And if utilities need to build new capacity, that will require copper wiring — hence the demand for the commodity.
That all makes sense. The rapidity of the moves does not. First of all, this is not something that we just learned. Maybe it has been more widely reported, but it should have been clear all along that if we bring huge networks of computers online, then they would need electricity to run them. Second, it’s not as though utilities can simply snap their fingers and add supply. Power plants take years to get approved and built. The change may occur, but it won’t be overnight.
Instead, this is emblematic of the level of speculation surrounding all things AI-related and in the markets as a whole. We can debate whether the Fed and other central banks are restrictive from an overall economic viewpoint, but it is abundantly clear that their policies are not restricting market speculation in the least. It takes money to chase stocks and commodities higher, and when we see a financial asset go vertical, it means that there is more than ample amounts of money flowing. This of course raises the stakes for Nvidia’s (NVDA) earnings report next week. If they can continue their enviable, remarkable string of beating estimates, raising guidance, then beating the raised guidance next quarter, that means that the AI trade can and will proceed apace. If there is even the slightest sign of weakness, however, much more than that stock alone will suffer. Markets are not pricing in much volatility for the coming weeks – VIX around 12.5 tells us that there is not much demand for hedges. This might be an opportune time to pick up some insurance ahead of such a consequential report.
Disclosure: Interactive Brokers
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