While traders are scratching their heads about how the stock market can continue to go up while the economic news continues to get worse, they also should be puzzled over the sharp rise in copper and other industrial metals in recent weeks. These metals move with building and manufacturing activity and a rise in their prices is not just an indication of an improving economy, but is also an indication of inflation - not the deflation that the Fed and its friends have been worrying about lately.
The base metals, copper, aluminum, nickel, zinc and lead, all bottomed in early June. They mounted lackluster rallies into the middle of July. Their rallies went into overdrive after Fed Chair Bernanke testified before congress that it might be years before the U.S. economy fully recovers. Stocks also mounted a significant rally on this gloomy news, which followed a host of economic reports with falling numbers that came in below expectations. Leading indicators had also turned down and were pointing toward an impending recession. Stocks and industrial metals should have tanked, but instead rallied strongly on the news. Only a lot of liquidity flowing into the financial system at that point could make something like this happen.
When trying to analyze the metals markets, the first place to look is China, the primary driver of demand. In June, China imported 212,000 metric tons (tonnes) of copper, 67,000 tonnes less than in May and a drop of 44% year over year. Moreover, projections came out for Chinese demand growth to ease for the industrial metals in the second half of the year. Then the HSBC Purchasing Managers Index for July came in below 50, indicating a decline in Chinese manufacturing. So far, none of this news has stopped the rally.
So if the news from China is bearish, the next place to look is the U.S. dollar. All commodities are priced in dollars and are affected by swings in the currency. The U.S. dollar peaked in early June at the same time that the industrial commodities bottomed. It has since lost about 10% of its value. However, much of this loss took place before Bernanke's congressional testimony and much of the base metal rally took place after. The metals rally has also been too big to be accounted for by the drop in the dollar alone. From the June low to the high of August 4th, Copper (JJC) rose 25%, Nickel (JJN) 24%, Aluminum (JJU) 23% and Lead (LD) 46%.
So we are left with a picture of strongly rallying stocks, even more strongly rallying industrial metals and lots of evidence of an economy falling apart. Has this situation ever existed before? Indeed it has plenty of times in world financial history. This is what happens when there's massive inflation. It ruins the economy, but makes the prices of assets go up because people want to get rid of their currency. Yet the economic elites are currently worried about deflation and not inflation. Well, that's also happened before as well. In 1920s Weimar Germany, economists even managed to prove definitively that deflation existed and that inflation was not a worry, so it was OK for the government to print all the money it wanted to. Of course, after inflation reached a trillion percent, many people became skeptical.
Disclosure: No Positions
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.
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