False Flag

Copper

As I write this week's blog, I am stuck for words for my audience. Those who bought the dip last week are now fighting the tape and second-guessing their optimism. Those on the sidelines have been paralyzed into inaction. Those who have only a passing interest are losing faith in the value of the advice they thought they could rely upon from so-called 'experts'. This is the fog of war - market style.

The mainly cosmetic cut-off of Russian imports by the U.S. will do little to starve Russia from the cash needed to prop up its economy in the short term. As they did with Iran. China will step into that breach and is already preparing term sheets for investments into Russian oil producers. Germany can't fully join the embargo as they mortgaged their energy independence years ago when the Greens forced the shuttering of nuclear power and approved the first Nordstream pipeline from Russia, handing them a weapon that is now pointed at Berlin.

In the non-energy commodities financial markets, commercials and speculators are scrambling now. To be sure, Russia and Ukraine are major commodity producers. Securing ample supplies of palladium, aluminum, and pig iron are all now threatened, as is wheat. This morning, the closing of the LME nickel market has thrown markets further into disarray. Hard assets are soaring across the board.

But I have not fully bought into the copper rally just yet. I think of it as a copy-cat rally that has jumped the gun, with less fundamental justification than other directly affected metals. Russia is a mere 3-4% of world copper production, hardly a squeeze candidate. Chilean labour disputes regularly disrupt multiples of that amount. And think of the effect on the economy this year as the twin threats of monetary contraction and economic deceleration on demand for copper. Production levels are set to rise again this year and inventories in China are rising. Copper is a more financially traded metal, so some speculators use it as a proxy for nickel.

How long these panicky markets last is unknowable. We were already looking at a slowing economy before the war and the hype around the commodity super-cycle had gotten a bit frothy, with Jeff Currie of Goldman Sachs leading the charge. Just replace the word 'oil' with 'tech' and he sounded like Cathie Woods. I believe that didn't go well for her.

Eventually, (not saying when) we will see a return to a 'normal' economy, and war effects will reverse themselves. But I doubt that will mean a return to 'normal' markets - ones that looked like 2021. The unwinding of the overvaluation from the stimulus-driven asset bubble will continue, retarding equity returns going forward.

How much the Fed can delay rate hikes and balance sheet normalization is open to question. In the short term, stagflationary effects may allow for a flattening out of rate hike expectations, but in the post-war scenario that sees a meaningful re-acceleration of global growth, they will need to step up to the plate.

Financials will lead the recovery as they always do. Once this commodity blow-off passes through the system, the long upward trend to higher yields will again drive investor expectations. The consumer will again benefit from the ample balance sheet and a renewed confidence that the fed is hiking for a 'good' reason. Lending will accelerate and replace higher rates as the primary focus of bank investors.

We are a long way from this rosy scenario. With Putin increasingly backed into a corner, the second siege of Moscow is a long way from ending, but I remain optimistic that the markets will endure this as they have other seemingly existential threats. I just keep focussing on the right flag.

Risk Model: 2/5 - Risk Off

The Canadian Investor, as seen with our Covid experience, has a much higher level of immunity to the current market turmoil than her U.S. counterpart. The advantages of our relative abundance of natural resources and stable banking system are showing up in the model's bifurcated readings. The RSI and 220dma readings are positive for the XIU at 53 and +5%. Contrast that with the U.S. market and we see a different story, with 35 and -4% for the SPY. As I said last week, Canadian stocks are now a safer place to be. How much longer can the Canadian dollar stays below 80 cents now? Once the flight to safety knee-jerk U.S. dollar bounce subsides, I look for a huge rally for our forgotten Loonie.

The Model also uses the CBOE VXV for a volatility gauge and the AAII Sentiment - a similarly U.S.-based measure. The weakness in financials was more pronounced in the S&P 500 than the TSX, reflecting their higher reliance on capital markets and higher valuations.

The only global measure is the Copper/Gold ratio. As for that, the Cu/Au reading is stuck in a tight sideways trading range as it has been since last year. I interpret this as a negative for risk-taking as the inability of copper to dominate is an expression of the duress that is currently holding back investors from fully committing to the bullish case. If the break-out in the flag pattern shown at the head of this missive was mirrored in an upward break-out in the one shown below, I would be more constructive. A cessation of hostilities in Europe would almost guarantee that outcome.

Copper/Gold Ratio