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Still No Clean Bill of Health From Dr. Copper


Copper's price movement continues to doubt the US bull reflation thesis. For Gray-Haired Bears, the time is nearing for a move either down in US markets, or up in copper.

Armed with the omniscient confidence that new all-time highs bring, US equity market bulls continue to maintain that economic growth is on the cusp of accelerating to the upside. Despite real GDP growth at year-over-year levels (currently 1.6%) more typically associated with recessions than expansions, bulls are steadfast in their belief that the "forward-looking" SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is still the best barometer of economic strength.

We would all benefit from an uptick in growth here, and I certainly hope the equity bulls are correct in their optimistic assumptions. However, hope is not an investment strategy. As an unbiased market analyst, I have to question why our old friend Dr. Copper continues to paint a different picture than the US equity market. With the US Manufacturing PMI recently hitting its highest level since April 2011, one would expect the metal with the PhD in economics to be surging higher. But to the contrary, copper (NYSEARCA:JJC) remains down 10% on the year and 30% below its 2011 peak.

Now there are many ways to explain away this disconnect to fit the bulls' thesis. Chief among these explanations is the fact that copper has become more of a China-centric story in recent years, given the country's increasing share of demand for the commodity. While this is certainly true and Chinese equities (NYSEARCA:FXI) have moved mostly in step with copper prices, is there not a strong interdependency between the US and Chinese economies? Simply stated: If demand for copper -- and therefore Chinese growth -- is slowing, can we reasonably expect US growth to accelerate here?

I don't believe that the odds of an acceleration are high, but my overall view is that one of two scenarios is likely to play out in the coming months: Either US equities reprice lower to reflect the fact that hopes for future growth have been too optimistic, or copper prices and emerging market equities (NYSEARCA:EEM) play catch-up and surge higher to confirm US equity market strength. The latter is the "fat pitch" thesis that I have brought up in numerous articles

Given how stretched US equity valuations are versus the rest of the world, neither of these scenarios is particularly bullish for US equities as an asset class play going forward. In the first scenario, long duration bonds (NYSEARCA:TENZ) would be the likely beneficiary; in the second scenario, emerging market stocks (NYSEARCA:VWO) would be the likely beneficiary.

On an absolute basis, the second scenario would provide support for US equities to extend their bull market run, keeping the Gray-Haired Bears in hibernation. The rising copper to gold (NYSEARCA:GLD) ratio currently provides support for this scenario, hitting a new YTD high just last week. And so while copper may not be signaling acceleration in growth, it is also not currently signaling a slowdown.

Which scenario plays out? Maybe both. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts currently favor bonds independent of stock badgering. Risk-off, or badger-on? Both can happen if near-term bonds catch a better bid than stocks. Intermediate-term, honey badger looks to want to move his money overseas, building a new home BRIC by BRIC.

Twitter: @pensionpartners
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No positions in stocks mentioned.

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