Caution Reigns

The January market dip was focused on profits taking.

Good results in various sectors brought selling, but not sell-offs. It is evidence that caution still reigns at the start of the new decade and isn’t really saying much else, for now. It does indicate wealth preservation after the ‘08 Crunch is, and likely will continue to be, the focus of “Boomers” who are nearing the end of their working lives. How long they are good with clipping low interest coupons is the next question on the table.

It took a while for this sentiment to make its way into the copper space, but the red metal’s price is now giving ground after having an extraordinary 10 month run. The 40 cent price decline has been quick, but is only an 11 per cent drop from the peak early in January. There has been about a 3 per cent gain to LME stockpiles since the price decline began in earnest. It is too soon to make much of this, but we still think it likely copper will move through support in the high $2s and could test the $2.50 area.

A price decline to that level would be near 30 per cent and could generate headlines about both copper bubbles and the peril to the broader economy. It would be a larger percentage than we thought was needed to test the market, but so far we have just seen froth blown off the market top; the mid $2s was the expected pull back when we got concerned about copper moving above $3.

The froth built in part due to the weak greenback, and it was US$ strengthening that finally tugged copper prices lower. That and speculators shifting away from the metal on some impressive gains. The US$ strength was generated by further moves to tighten lending in China and fear of sovereign defaults in Euroland. Currency fluctuations will continue influencing copper’s price for the next while. Has this been a bubble?

Price and supply gains in tandem do fit the basic definition. However, we wouldn’t call the current LME stockpiles in the 15 days of supply range a major “oversupply” even though they represent the largest margin we have seen for about a decade.

Copper’s broad mine supply is typically well balanced to demand, and barring a major supply disruption it will take a while to eat through the excess stocks. But, we are talking about a short run phenomenon. “Bubble” is getting bandied about a lot lately. It should be reserved for markets in which supply excess built over a long period, and that will take a long time to repair because of systemic damage.

We have enough after-bubble markets to deal with that we don’t need see more in normal market overreach. We may not be quite ready to jump into copper’s deep end just now, but the enthusiasm for its market has simply been because it is healthy.

In fact, amidst the concern about what direction the global economy is taking, a rare drama is unfolding in metal’s smelting arena. Codelco and BHP have both recently negotiated lower charges from East Asian copper smelters, low enough in fact to render the smelters marginal. It has usually been the smelters that dictate charges, so this is the tail wagging the dog.

The combination of a near term smelting overbuild in China and a mid term concern by all smelters about a lack of mine supply is at play here. For those of you who glaze over when we talk about century old trends, or even millennia old trends (ok, one of us just joined the glazing), it is just this sort of shift that we are looking for.

While the supply concerns are most prominent in the copper subsector, they do apply to other metals. The bottom line impact for HRA readers is that smelting companies are seeking out direct links to deposits. This will be a growing source of funding projects, and mean more take-overs in due course. It will also mean more focus on that part of the sector from us going forward.

Gold is rebounding nicely, in line with shifting sentiment for the greenback. The down tick in this market has also been about profits taking, at least in part. That currency traders going long the Dollar was able to cap gold more quickly than it did copper is still the most interesting bit of news to come from the recent trading.

How the next while plays out is still subject to diverse opinion, as it should be during such a major shift global of economic weightings. The US$ is still being viewed as both a safe haven by some even while others focus more on the need for the greenback to soften longer term so the US can generate a positive trade flow.

Every bit of good economic stat has bond traders weighing whether it results from commerce or stimulus at work, and pondering whether the appetite for low interest T- bills can continue.

Conspiracy theories abound about “someone” holding the equity markets up. We find this ironic; the US Treasury is quite happy to see equity markets pull back and drive buyers into the Treasury market.

Debt troubles in Europe continue to generate currency swings and talk of (of course) a gold bubble. Default in Euroland would lift the US dollar, but bears should remember gold is a popular reserve asset lately too. The endgame could be better for bullion than most expect even in a default scenario.

We doubt a comfortable trend line will be obvious for a while yet. The one assumption gaining currency is that China’s growth is central to sorting out the way ahead, and that some concern about its rapid rise in bank borrowing is warranted. Even while reminding again that this borrowing is from domestic savings, we have to agree. So apparently do Chinese officials.

A recent musing we heard spoke about a “hard landing” in China, but even this bearish stance meant a growth rate of only 6 per cent. Not reason to drop the wheels in our book, but still a caution since it speaks to the difficulty of what to focus on during the major shift that is underway.

That shift is accelerating, and this means uncertainty that will continue to roil markets. This lack of clarity as much as anything else should keep gold on an uptrend. We are certainly looking at base metal players, but gold will remain our main focus for the time being.

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