Recap 9-20-11

Main Items:

  • S&P cut Italy’s credit rating to A from A+ with a negative outlook.

Overseas:

  • German ZEW survey improved to -43.3 in Sept vs -45 exp. And -37.6 prev. The current situation component declined to 43.6 vs 45 exp. and 53.5 prev

Commentary:

Copper prices have recently touched YTD lows:

This is important because copper has had an uncannily tight leading relationship to the S&P over the past 4 years. In particular, Copper appears to have been leading the S&P by almost exactly 12 weeks, with several incidences of coincident local extrema. (In other words, it is a chart monkey’s dream)

Of course, correlation does not imply causation, but when a dandy chart like this lines up with one’s fundamental views, it’s tempting to put more weight on it. If the relationship holds, we’ll see the S&P reach a local high around Thanksgiving before falling again.

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6 thoughts on “Recap 9-20-11

  1. Can’t tell if you think there’s a genuine relationship between the copper 12wk lead & S&P or not…I think it’s plausible that copper is functioning like an unusually accurate very near term PMI indicator right now (tight supply so a fair bit of price vol makes this very visible), and the equity market is just trying to get a read on whether the super-high earnings rates of this cycle are going to hold up. could be even simpler though–a little inflation via higher comms prices ends up convincing equity mkt that growth is strengthening, since in this environment i’d think rising BEIs are also correlated with rising equities. thoughts?

    1. Hi anon –
      It’s quite possible that markets are using copper as a PMI indicator, but since 2Q, copper has actually not been a good predictor of PMI… copper has been stable until recently despite PMI falling from 61 to just above 50. The BEI argument is also plausible, but the chart of the 10y BE vs SPX suggest that the relationship is coincident. In any case, BEI’s also suggest equities lower over the intermediate term.

      I honestly don’t know exactly why the relationship exists. I thought that perhaps copper price action is reflecting the real investment demand from China given that it represents the lion’s share of demand growth, but the problem with that argument is that very little of global corporate earnings actually come from China given its trade/capital barriers. Another possibility is that copper price action is reflecting real EM demand growth, which has been driving global corporate earnings. Or expectations of earnings.

      I wouldn’t normally put much weight on an overlay chart, but there are few exceptions here:
      1) copper prices have a long history as an indicator of cyclical growth
      2) the relationship appears unusually strong over a decent period of time
      3) the chart lines up with my expectation of how markets will perform, an expectation that I had before seeing the chart. This could simply be reinforcement bias, but when combined with the other options listed above, it strengthens the confidence in my expectations.

      Hope that helps!

  2. Be aware that copper on the 2 main futures exchanges does not trade like oil or other commods in that it has not the standard front month / spot delivery liquidity.

    This is CME’s contract spec:’….Trading at Settlement is allowed in the active contract month. The active contract months will be March, May, July, September and December.”

    Note the spikes in volume on yr chart corresponding with above cycles.

    LME copper futures: the most liquid contract is the ‘3M’ , meaning 3 months (12 weeks!) forward delivery .
    On the LME, the ‘cash contract’ is normally traded as a diff off the 3M contract ( ie ‘cash’ trades as contango or backwrd discount/premium off the 3M benchmark )

    I’m not taking anything away from your argument that copper futures’ trend has strong correlation and possibly causation, to SP index. My point is only that the 12 week lag has some logic behind it.

    Would be interesting to see where the LME copper futures contract correlate to an EU index such as FTSE100, although the FTSE is full of energy + mining companies so be aware.

    But it not for nothing it’s called many times Dr. Copper.

    1. Thanks for pointing that out. Taking that a bit further, the location of exchange warehouses should give us an idea of where the demand for copper could be.

      The location of non-ferrous LME warehouses are all in the US, EU, Asia and Australia:
      http://www.lme.com/warehouse/locations_non-ferrous_metals.asp

      But given that people arb futures/forward prices, we also should include COMEX and SHFE warehouse locations.

      Interestingly enough, there are no warehouses that I see in Latam. So it appears that physical demand is predominantly coming from Asia and Australia.

      1. LME warehouse locations: the rule is that LME will not ‘authorise’ warrantable stock ( ie ”LME stock”) in locations with an imbalance of supply ( ‘production’) over demand.
        In other words: LatAm has no LME warehouses because so much of copper comes from that area and relatively little is consumed there. Other example: LME has copper on warrant in Dubai(Jebal Ali) but NOT
        aluminum. Reason: so much alu is produced in Persian Gulf area.
        LME does that so the stock levels are not primarily a game that the producers can play. So the ‘rule’ is: LME warrantable stock only in regions of large , physical demand and good accessibility by ships/logisitics and total free of tax rules & regulations so any holder of a warrant is totally free of taking metal in/out of the warehouse.
        The big LME stock piles are typically in W.Europe (Rotterdam) , USA ( N.Orleans = big one ) , S’pore and S.Korea. Note: LME has no authorised warehouses in all of China.
        Pls note: it’s not the LME who holds any stock , it’s the brokers and individual counterparties ( speculators etc) who hold warrantable stock.

        Last note: it’s amazing that few big financial institutions (such as JPMorgan, GSachs) and big traders (Glencore,Trafigura) have taken ownership of the metal warehouse biz in recent years. They have bought out the private ownership of these warehouse so that they can play that LME warrant game better than anyone else. Also a nice ‘hedge’ ( being in warehouse biz and collecting rent) vs when the brokerage biz on base metals is not so hot anymore.

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