Copper Bottom

My wife recently ordered and new set of very expensive pots and pans for the cottage. They incorporate a unique feature - a copper core. Knowing that copper is a good conductor of heat, this made sense to me. But it got me thinking...does the market have copper bottom too? Let's go to the charts.

Positioning is at a bearish extreme that has marked recent bottoms. The grey lines indicate the net position of traders on the COMEX, currently at three year lows.

Seasonality will soon turn positive. Summer has seen many a July - August rally for the red metal. Along with oil seasonality, this is one of the most consistent patterns I have witnessed over many years.

Copper Seasonality

The depressed level of the copper/gold ratio is also at an extreme - and reversing.

And what about the fundamental case?

Wood Mackenzie, the international consulting firm, has estimated that new projects are required in the future to avoid a major supply shortage. Even with the addition of the "probable" category of new copper projects, future supply will be insufficient to meet demand. And many projects are now being deferred by the uncertainties driven by Trump's trade tirade.

So all things point to a rally. So what do we need to feel confident in making a bet on copper?

Admittedly it's a bit scary, wading into the most economically sensitive parts of the market right now. The deceleration of global economies that has resulted from last year's interest rate normalisation is making for some scary headlines. Last week saw some sharply lower employment numbers that further battered sentiment.

We need market participants to feel confident about the future. We need them to expect things to get better. We need them to reduce risk aversion. We need an all clear signal.

That is a big ask while Trump is happily lurching about, trying to create his new world order. Now that he has cowered the Mexicans into falling in step with his illegal immigration narrative, the bit is in his teeth. Look for him to keep using his favourite 'trade card' to achieve his political agenda.

Short term, everything is pinned to the China-U.S. trade deal. Good luck handicapping that one. China is now starting its second 'Long March', this time towards economic freedom from the west. 'Belt and Road' is all about the Asia-fication of their economy. In their view, the sooner they create the second Great Wall, the one between them and America, the better.

That will take time. But China, which prides itself on a 3,000 year history, has all the time in the world. Unlike his hero, Vlad-the-Impaler Putin, Trump's days are numbered, even if he does somehow manage to get re-elected.

Meanwhile, we are left to trade the erratic ebb and flow of sentiment. Judging from the market's reaction to the unexpected Mexican capitulation, there were a lot of shorts to cover in risk assets. The head-snapping melt-up is continuing this morning. As I pointed out, given the sharp drop in global yields, the equity risk premium was rich, incenting asset allocation moves into equities.

But how are we expected to process Trump's badgering of the Fed? Now that central bank independence is under siege, can anybody believe their policy moves aren't being orchestrated by the Tweet House? Any dovishness is now politicized.

We know that the Fed's patience pivot has been responsible for righting the ship since the Christmas eve low. But now that the bond market has been force fed an avalanche of cash from risk refugees, how do we get back to the normal rate structure that the Fed so craves?

The global shortage of positively yielding, low risk assets is distorting the reaction function of the market. Central banks around the world are singing from the 'lower for longer' song sheet. Australia implemented a rate cut and India and the PBOC are contemplating one. After the tepid response to the rolling out of "TLTRO III" Europe is desperate come up with some new monetary easing acronym. Maybe they could use H.E.L.P?

With so many fingers on the scale, how do we use the bond market to accurately measure the economic environment?

The inversion of the curve, created by these powerful non-domestic forces, is potentially sending a false narrative about recessionary conditions in the U.S. The mistake the Fed continues to make is looking at domestic data to aid them in guiding what is now a truly a global policy framework. If tomorrow's CPI data isn't surprisingly weak, they won't have any cover to explain a rate cut.

Many are using just such an argument to dismiss the message being sent by the inverted curve. But saying 'this time is different' does not come easily from my lips. The corrosive effect on the banking system of an inversion continues to show up in the pathetic relative strength of JPM and BAC against the market. This isn't encouraging.

But the global economic cycle, bruised and battered as it is, has yet to fully implode. Slowing to trend growth of 2% is not a recession. Already there are signs from the transportation markets that demand is picking up. The robust market rally we have just enjoyed is, itself, removing pressure on the Fed to cut.

Unless hopes for the China U.S. trade deal spectacularly flame-out in a full-on cage match, the scenario of multiple rate cuts currently implied by the bond market is doomed. Trump could easily use his Mexican playbook to guide him in his G20 deal-making. Most likely they will kick the can down the road and create a cease-fire. The slightest good news on that front will create a huge sell-on-news rotation out of defensive assets like bonds and money will flock into riskier assets - like copper. Summer rally on!

Bonds, the risk free asset of choice is anything but risk free, if you are at all optimistic on the trade front. Bondies beware. If you don't get a Trump-Xi hissy fit and a Fed cut, you are looking at major pain.

In that case, Bonds would need to do something to deflect attention and create some buzz. Maybe they can rename themselves 'Beyond Bonds'.

Risk Model: 2/5 - Risk Off

Sentiment and copper market are at extremes, but still in the 'off' position. If you want to buy, don't jump the gun just yet.

Implied volatility has dropped, but not enough to trigger a 'buy' signal.

The short covering is just about done now. Sober second thoughts will shortly start creeping in to market thinking as we are still in an elevated state of uncertainty vis-s-vis G20 talks.

A not-weaker-than-expected inflation print tomorrow would be devastating for the rate cut bulls who have been chasing the rally here.

Fade this market. Buy some TVIX for the next week or so. Tuesday at 11 would be a good time.