Copper Speaks, We Should Listen

Because of its many industrial applications, copper has leading indicator status when it comes to the economy. Keeping an eye on the trend in copper can help confirm or invalidate economic analyses.

How does the recent increase in the stock market compare to copper’s performance? Between May 9 and October 16, copper rallied strongly, but since its peak on October 16 it has declined 9.0%, while the SPX has risen 2.8% over the same time period. Has the stock market got ahead of itself?

Interestingly, the top in copper prices coincided with the start of the National Congress of the Communist Party of China (NPC), October 18–24, and prices have been falling ever since. There may be a real connection between these two events. Leading up to the NPC, in an effort to instill public confidence in the “system”, the Chinese leadership was more relaxed about the excess leverage in its financial system, but once the congress was over the leadership started tighten-up on the excess liquidity coming from the Chinese shadow banking sector. Increased regulatory efforts negatively affect growth and, since China accounts for nearly 50% of global copper consumption, copper prices are affected as well. In addition, the Shanghai stock exchange has followed copper lower (chart below).

Falling copper and falling Chinese equity prices are in-congruent with the prevailing narrative of global growth expectations that have been underpinning stock prices. The chart below shows how the S&P 500 and the Shanghai index have diverged since the end of the PNC.

Copper’s price drop may be a temporary correction following its 30% rise and its price could recover, allowing Chinese stocks to rejoin the SPX in its relentless ascent. But if selling persists, then future data may not demonstrate the economic growth that present stock valuations are implying.



Equities

Sentiment
Again this week, the AAII investor sentiment index was essentially unchanged; bull sentiment +0.9% to 26.9%, neutral sentiment -3.5% to 28.9%, and bear sentiment +2.6 to 34.2%. This represents an increase in fear of about 5% over the last two weeks. The market continues to climb the proverbial “wall of disbelief”. Bear markets do not start when there is this much fear (chart below).

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The chart below shows the Rydex bull fund asset allocation and the bear:bull asset ratio, in addition to the AAII sentiment index. The pink rectangles highlight the similarity between the present and the lead-up to the 2015 correction. If this pattern repeats itself, we could see a significant correction in the not-to-distant future (chart below).

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The put-to-call ratio has started to turn upward. If this continues, there is an 80% chance of a correction (chart below).

Technical
The long-term technical averages continue to demonstrate a late-stage bull market and no warning signs are evident. The 8-month moving average falling below the 12-month moving average, would be a long-term bear signal. The ADX trend still has room to move up before it bumps up against the down-sloping major trend (blue dashed line on chart below).

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Fundamentals
The important 10-year minus 2-year rate differential remains comfortably in positive territory. Its slope points to an another 12-to-18-months before the probability of a recession becomes significant (chart below).

­Oil

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Gold

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Technically, gold remains under pressure (chart below).

The USD/JPY FOREX ratio has bounced off of the 38% Fibonacci retrace, and a MACD bear cross-over has been averted (chart below).

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The large gold-futures speculators lowered their long positions by 25k contracts, while the swap dealers decreased their short positions by the same number. The positions, however, remain elevated and bearish for gold (chart below).

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We wish our subscribers a profitable week ahead.

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