Red-hot copper hit another new all-time high this
week, extending its mighty upleg to a 66.6% gain
since June! As always after any
strong run, investors and speculators are pretty excited about this essential
base metal these days. But this
incredible bullishness, along with overbought technicals,
actually suggests copper is on the verge of a major correction today.
Corrections are perfectly normal, necessary, and
unavoidable within even the strongest bull markets. All prices flow and ebb, advancing two steps forward before retreating one step
back. These ebbings
are critical because they rebalance sentiment, bleeding away excess greed and
complacency before it grows to upleg-ending or even
bull-ending extremes. Corrections
keep bull markets healthy.
It always amazes me how much traders resist the very
idea of corrections when markets near major highs. As investors and speculators, our
mission is to buy low and sell
high. The best opportunities to
buy low within any ongoing bull market only occur after a major correction
has run its course. Only then is
sentiment poor enough to yield seriously beaten-down prices in the stock
markets and commodities.
This innate resistance traders
harbor against corrections just before one ignites is often buttressed by fundamental arguments. But while core supply-and-demand
fundamentals do indeed drive the primary secular-bull trends, they are completely irrelevant for
corrections. Corrections are
sparked by extremely unbalanced sentiment and overbought technicals. Fundamentals have nothing to do with
them.
In copper’s case, today you will often hear
that copper is heading higher because of fundamental factors. China is buying, the emerging world is
industrializing, existing mines are depleting, miners are striking, new mines
are years away from production, et cetera. But realize these indeed-bullish
supply-demand trends have been in force more or less continuously since late
2001 when this secular copper bull was stealthily born.
Despite the inherent bullishness of global demand
growth outpacing global supply growth on balance, copper still had to weather
many major corrections over this
past decade. So don’t fall
into the rookie trap of rationalizing away extreme sentiment and overbought technicals with fundamental arguments. All bulls correct from time to time no
matter how awesome their underlying fundamentals happen to be.
Unfortunately copper doesn’t share the stock
markets’ excellent array of sentiment indicators. But if you look around, it is readily
apparent consensus opinion is pretty darned bullish on this base metal. Articles in the financial press
advance endless fundamental arguments for why copper is heading higher. And professional money managers,
traders, and analysts interviewed on financial television expect the same.
But even though copper doesn’t have some neat
indicator like its own VIX, its technicals are
clearly overbought today. Its
price has risen too far too fast to be sustainable. How can we know? By comparing copper’s recent
highs to this metal’s technical conditions just before its previous major corrections. We’ll start out by examining the
blue copper line compared to its black 200-day moving-average line.
In order to define “too far too fast”
for copper specifically, we need some kind of baseline. And its 200dma is a perfect one. It gradually rallies to reflect the
higher prevailing copper levels as this secular bull marches on, but still
moves slowly enough to distill out all the day-to-day volatility. Expressing any price as a multiple of
its 200dma (dividing the price by its 200dma) is the basis of my Relativity trading system.
In copper’s case, earlier this week this metal
was trading at 1.287x (times) its 200dma. Compare this to the Relative Copper
readings before each of its previous several corrections. In November 2010 before a sharp 8.7%
retreat, this metric stretched to 1.217x. In April 2010 before copper plunged
23.4%, it climbed to 1.218x its 200dma.
And in January 2010 before this metal fell 18.7%, rCopper
peaked at 1.334x.
So we have plenty of precedent over this past year
alone showing that copper is very overextended and overbought once it
stretches 20%+ beyond its trailing 200dma. rCopper
running 1.2x+ is the point where traders need to start being wary of an
imminent correction. Copper has a
tough time sustaining an advance that sees it rally far enough and fast
enough to exceed this benchmark.
And this week we were well beyond that warning sign and pushing the
super-extreme 1.3x level!
Now this alone warrants a very cautious near-term
outlook on copper. The odds
overwhelmingly favor a major correction.
Again this has nothing to do with fundamentals, which are utterly
irrelevant to short-term price action when sentiment and technicals
reach extremes. Personally I
wouldn’t go long copper or copper stocks based on this rCopper indicator alone when it’s at these
levels. The near-term downside
risk is far too high.
But add in a couple of other major factors driving
copper prices, and the odds for an imminent correction approach
certainty. They are the state of
the general stock markets today and the trends in the London Metal
Exchange’s global copper stockpiles. Each alone is a very ominous near-term
portent for copper, and considered together along with copper’s
overbought technicals present a nearly-ironclad
correction case.
Believe it or not, the major driver of copper price action in its current cyclical
bull since early 2009 is the state of the US stock markets! It sounds crazy at first,
shouldn’t copper be reacting to its own supply and demand and not
stock-market action? Of
course. But the stock
markets’ fortunes have a massive
impact on traders’ sentiment worldwide. When the stock markets are up, they
feel good and are more likely to buy commodities including copper. When they are down, traders dump
everything including copper.
While this link is purely psychological, sentiment
is what drives most short-term price action in anything. And there is some logic underlying
this relationship. Advancing
stock markets lead traders to expect an improving world economy, which means
higher copper demand. So they buy
this metal and the stocks of its producers. Retreating stock markets make traders assume
the economic outlook is deteriorating, implying lower copper demand. So they react accordingly by selling
the copper complex.
The best way to measure the US stock markets’
performance is through the broad S&P 500 stock index (SPX). It contains the 500 biggest and best
American companies that collectively represent the vast majority of the total
market capitalization of the US stock markets. In the chart above, I superimposed the
past couple years’ copper action on top of the SPX in red. Their correlation is
visually-astounding!
On a hard statistical level, this critical copper-SPX
correlation is rock-solid mathematically as well. Since those brutal post-panic SPX lows
in March 2009, copper has had a correlation r-square with the SPX of
93.4%. Over 93% of all the daily price action in copper
over the last couple years is directly explainable by the SPX’s
own! For whatever reason, copper
traders are buying and selling copper in sync with the SPX.
And realize this relationship does indeed flow in
this causal direction, from the SPX
into copper. Every trader in
the world watches the stock markets like a hawk. Their behavior and resulting
psychological spillover affects everything else including copper. Meanwhile, general stock traders are
definitely not eagerly watching copper prices to guide their every decision
on buying and selling equities.
The SPX is definitely influencing copper psychology, as suggesting
copper drives the stock markets is absurd.
Note that all three of copper’s latest
corrections in this bull, and 5 of 6 in total, corresponded exactly with
pullbacks (less than 10%) or corrections (greater than 10%) in the SPX. Last November copper sold off 8.7% in
just 4 trading days over a span where the SPX retreated 2.9%. Between early April and early June,
copper plunged 23.4% over a span where the SPX corrected 10.7%. The worst copper correction of this
entire cyclical bull was directly driven by the only correction in the
SPX’s own cyclical bull!
And a year ago in January and February, copper
dropped 18.7% in less than 4 weeks while the SPX fell 7.0% in its biggest
pullback of this bull. Other than
that initial post-panic recovery in 2009, which was an anomalous situation,
every copper correction has perfectly corresponded with a parallel pullback
or correction in the general stock markets. A retreating SPX scares traders into
reducing all their risky trades, including copper exposure.
This is super-relevant today because the stock
markets, for their own internal reasons that have nothing to do with copper,
are also due for an imminent correction.
I wrote an essay several weeks ago that explains exactly what is going
on in sentiment and technicals in the SPX and why a correction looms. When (not if) the SPX inevitably rolls
over, copper is going to get sucked into the maelstrom of selling like usual.
Copper just can’t resist the overpowering
bearish sentiment that floods out of the stock markets when they are
correcting. Almost nothing can,
other than the US dollar and
Treasuries which act as temporary safe-haven destinations for capital in
times of mushrooming anxiety and fears.
And today’s coming SPX correction is likely to be major, so all investors and
speculators need to take its risks very seriously.
If you compare copper’s declines in its
half-dozen corrections in this cyclical bull to the SPX’s parallel
ones, both shown above on the chart, it is crystal-clear that copper tends to
amplify stock-market downside. It is much more speculative than the
stock markets, usually at least
doubling SPX selloffs. So a
garden-variety 15% SPX correction, no big deal at all, would probably lead to
a massive copper correction approaching a
third. Copper equities would
get utterly slaughtered.
Several other factors argue for a serious copper
correction beyond its extreme technical overboughtness
and SPX-correction risk. After
just hitting new all-time highs, copper is ripe for a selloff. Corrections off of records tend to be
more severe, as such highs attract in new traders who buy near the top. These weak hands are easily spooked
into selling fast.
In addition, copper hasn’t seen a material
correction (over 10%) since last spring.
It has rallied in a tight uptrend mirroring the SPX ever since,
leading to very unbalanced
sentiment. The longer any bull
advances without a rebalancing selloff, the greater the odds one is coming
soon.
And there is one final factor to consider that will
really weigh on copper once selling starts. And it is fundamental! While fundamentals don’t matter
in corrections sparked by sentiment and technicals,
any temporarily-negative fundamentals can still add to this selling
pressure. They exacerbate the
bearishness and worries sparked by selling-off stock markets. Today the LME’s copper
stockpiles are climbing again!
The London Metal Exchange runs a global network of
warehouses that act as a buffer between copper miners and copper
consumers. While most copper
mined is shipped directly from producers to consumers, occasionally a miner
will have excess production or a consumer will need more copper than
usual. So these physical players
can directly sell to or buy from these LME warehouses. The LME publishes its aggregate global
copper-stockpile data daily. And it greatly impacts copper-price trends.
Prior to that epic once-in-a-century stock panic in
late 2008, copper prices trended inversely
to LME stockpile levels. When
these above-ground copper stockpiles were rising, copper prices would fall as
traders sold it because supplies weren’t as tight. When stockpiles were falling, copper
prices were bid higher to reflect the leaner buffer between supply and
demand. There were actually times
when LME stockpiles represented only days’
worth of global copper consumption!
Copper challenged $4 then.
During the stock panic, copper plummeted with all
other risky assets thanks to the immense psychological splash damage from the
plunging stock markets. But there
was actually something of a fundamental basis for some of copper’s freefall, as LME copper stockpiles
rocketed up dramatically. Thanks
to the stock panic, the great majority of the business world feared a new global
depression. So copper consumers (factories making
products using copper) slowed their production and bought less LME copper.
Then in early 2009 as those silly and irrational
depression fears abated, LME stockpiles started falling again and copper rallied
sharply. But these critical
stockpiles soon stabilized at much
higher levels than what existed before the stock panic. So traders wondered whether copper
prices would stay lower (around $3) for a while to reflect the reduced
scarcity and risks of a supply shock.
And initially they did.
But as the stock markets recovered out of the panic
and the SPX soared, speculators flooded into copper again to bet on the
mending global economy. So
between the middle of 2009 and early 2010, copper prices rallied despite LME
stockpiles blasting back up above their same extremes seen in the heart of
the panic. Copper was still
recovering from its own ridiculously-low panic levels, which contributed to
this particular disconnect from its usual inverse
relationship with stockpiles.
Then after consolidating sideways in a volatile and
choppy manner in the first half of last year, behavior driven by the pulling
back and then correcting SPX, copper started surging again last summer. And there was some basis for this
rally in the stockpile draws, until early December. At that point LME stockpiles bounced
just under 349k metric tons and started rising. In the 8 weeks since, LME stockpiles
have surged 14.2% higher at best while copper has rallied 24.6% at best
(since mid-November). This is a big disconnect!
So for the copper fundamentalists out there, ever
since this metal was trading around $3.90 in early December the copper gains
haven’t been righteous.
Copper should have fallen since then on rising LME stockpiles, but
instead it was bid higher.
Why? Because all the
bullishness spilling out of the rallying stock markets bled into copper like
usual! From its recent all-time
record high of $4.60, copper would have to plunge almost 16% just to return
to levels it should have started correcting from in early December!
The $0.70 run since then is all froth, pure
speculation spurred on by the strong stock markets. While copper’s imminent
correction is going to erupt for sentimental and technical reasons, these
bearish near-term fundamentals could really exacerbate this selloff’s
sharpness and depth. While this
fundamental disconnect alone isn’t sufficient to call for a correction,
considered in addition to everything else it is quite ominous.
So what to do?
If you are an investor, relax and don’t worry about it. You are holding your copper stocks for
many years so short-term corrections are ultimately meaningless. But gird yourself to weather the
psychological storm corrections bring.
Expect it and the copper selloff won’t worry you like it would
if you had no idea it was coming.
But if you are a speculator, this imminent copper correction is a huge
deal.
You should realize gains in short-term copper-stock
trades before copper starts
sliding. Just like copper will
amplify the SPX correction, copper stocks will leverage the metal’s own
decline. So we could be looking
at severe corrections in copper
stocks, making locking in existing profits imperative. On the bright side, after this copper
correction matures we’ll see some amazing buying opportunities in
thrashed copper stocks. Selling
before the correction ensures you will have a big cash war chest to buy the
bargains left behind in the correction’s wake.
At Zeal, this is always our strategy trading
commodities stocks. We
relentlessly study the markets to gain the wisdom and knowledge necessary to
identify high-probability toppings right before major corrections, and high-probability
bottomings right after them. Then we can buy low after corrections
and sell high right before the next one.
It is a conceptually-simple yet wildly-profitable approach when properly
applied.
Over the past decade
our real-world trading results derived from our carefully-honed skillset have been outstanding. All 235 stock trades made in our
flagship Zeal Intelligence
monthly newsletter since 2001 have averaged annualized realized gains of
+52.4%! You can’t imagine
how fast your capital grows with these kinds of returns. Subscribe to our
acclaimed monthly or weekly newsletters today
and find out! We’ll be
launching new high-probability-for-success copper-stock trades once this
correction matures.
The bottom line is copper is due for a major
correction. Sentiment in this
metal is wildly bullish thanks to its recent massive upleg
and new all-time highs. Copper is
very overbought technically, it has rallied too far
too fast by its own bull-to-date standards. And it has ignored a major trend
change in its LME stockpiles in order to follow the stock markets higher. Together, all this is a recipe for a
serious selloff.
Compounding these risks, copper has an
incredibly-tight positive correlation with the US stock markets. And they are due for a major
correction of their own. When they
roll over, copper is going to get crushed like usual. On the bright side, a copper
correction will drive serious carnage in copper stocks. If you can prudently amass cash before
the slide, then after this correction runs its course you can buy some of the
best copper-stock bargains seen within this ongoing bull.
Adam Hamilton,
CPA
Zealllc.com
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Questions for
Adam? I would be more than happy to address them through my
private consulting business. Please visit www.zealllc.com/adam.htm for
more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that I
am not able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000
- 2006 Zeal Research (www.ZealLLC.com)
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