Dr. Copper's PhD -- Checking the Accreditation

The widely-followed MarketWatch published a story that will, no doubt, scare the daylights out of individual investors who subscribe to their service.  This is the key conclusion:

NEW YORK (MarketWatch) -- A sell-off in commodities -- from copper to crude oil -- over the past few sessions is telling some veteran market watchers that a slowdown in economic growth, likely one of considerable magnitude, is already underway.

In the last two days alone, commodity prices seem to have fallen off a cliff.

The article relies heavily on an array of bearish pundits, but let us focus on the value of copper prices as a leading indicator.  Barry Ritholtz is quoted on this point as follows:

Copper is the metal with a Ph. D. in economics," Ritholtz said. "It's used in the wiring of homes and offices, in plumbing in construction, and it's also a key component in electronic goods. "When it softens, it means we're making fewer homes, offices and computers.

Since we are all vitally interested in leading indicators of the economy, this seems to be important information.  There are two troublesome points.

1. Current copper usage looks like a concurrent indicator, not a leading indicator.  In housing, to take the example used in the article, the leading indicator is building permits, not current construction.  Hmmm.
2. Prices are a function not only of demand, but of supply. A good question is whether actual copper consumption is declining, or whether pricing and supply have met in driving down prices.

Since this is a story about worldwide economic growth, it makes sense to look to China, the largest copper consumer and importer.  A frequently-cited Bloomberg story from a week ago makes it appear that Chinese consumption is falling.

A careful reading of the story -- not just the headlines -- makes it clear that it is discussing 2006 consumption (old news) not projections for 2007.  Another source, The Economic Times, seems to clarify this point.  The Forbes story cites data that does not consider drawdowns from stockpiles.  It also does not look ahead to 2007.  The Economic Times story points out as follows:

China’s actual copper consumption may grow by 3 to 5% this year, and by as much as 5% next year, Shen Haihua, vice-president at Maike Futures Co, said. Chinese copper producers and consumers have de-stocked 75,000 tonnes of the metal in the first 11 months of this year, while the State Reserve Bureau has disposed of 200,000 tonnes, Ang Xiaodan, an analyst at Minmetals StarFutures Co, said.

This is obviously a widely variant view on Chinese consumption.  So why are prices falling?

One answer is that increased prices caused a decline in demand, as noted in the story.  One might well expect that declining prices may stimulate demand.

Another answer is an increase in supply, notably from Chile (the world's largest supplier) after a period of supply disruptions.

 

A further careful reading of stories about falling copper prices reveals that traders were responding to reports on U.S. economic data!!  One trader is quoted as saying "the charts look terrible."  If this is true, the prices are not really a leading indicator.  The prices reflect traders looking at the same economic reports we all are seeing.

At "A Dash" we try to look a bit more deeply into economic reports, figuring out what it all means.  Since we are not trading copper futures, the supply/demand dynamics of that market are important only insofar as there are implications for economic growth.

There is nothing in the current data that is frightening on the growth front.  (Oil prices, for example, are down on weather, not demand).  We might note that the very same sources who now cite falling commodity prices were singing a very different tune when those prices were rising.

When commodity prices were rising, it was a leading indicator of inflation, and the need for more Fed tightening, destroying the economy.  Now, when prices are falling, it shows that a recession is imminent.  One wonders what data these analysts would accept as a signal of solid economic growth.

Meanwhile, many leading Street analysts point to commodity prices as a sign of a recession. 

Investors who can see through this doubletalk have an excellent opportunity.

Comments

[oldprof]

Bill -
Thanks for your excellent observations. One of the fascinating things about trading and investing is that there are many ways to do well. One variable is the time frame.

For long-term investors, energy stocks (to take a commodity example) may provide an opportunity. We like the "upstream" names, but they get caught up in the front month spot prices because they are in the ETF's.

We use models with different time frames. It is sometimes correct to add to positions in one time frame, and at the same time, it can be right for those on the speculative trade to sell. Trading risk/reward differs from investing, as you indicate.

[Bill aka NO DooDahs!]

The same dips-, er, pundits currently expressing that "Dr. Copper's" fall is predictive of a fall in "the economy," were notably lacking in talking up the strength of "the economy" when copper was marching from $1.50 to $4.00. I wonder why? Perhaps because they only present data which supports their mostly unchanging opinions?

Regardless of the relationship between the futures price of copper and the various inaccurate (and meaningless to active, nimble speculators) measurements of "the economy," it is apparent to any with eyes that rampant speculation had caused a disconnect between *several* commodities and their "fundamentals" - copper included.

Some of us made money riding the speculation up, and I am certain that some will make money riding it down as well.

We're not *all* interested in leading indicators of "the economy," for two reasons. First, what most people call "the economy" is simply an inaccurate, aggregate hodgepodge that is reflective of the reality for no one individual in particular. Second, "the economy" doesn't move the financial markets in the slightest. What moves the markets is money changing hands, and retail traders can make exceptional returns just following the money.

Love the blog! I wind up coming back here often!