The Doctor Will See You Now

Virtual meetings are now a widely accepted practice in this strange COVID world. Various service providers have adapted quickly to this new reality. (I'm a big fan of Zoom Yoga). The medical establishment, usually not known for being tech-savvy, has grudgingly come on board as well. As a prime example, yesterday Pat and I had an appointment with our family physician by phone, in lieu of our annual physicals. Although it lacked the element of human touch, a necessary feature for a complete diagnosis (I think you know what I mean), our doctor did her best in conducting the analysis. But I was left with a sense of doubt about the efficacy of this approach. Did she get the diagnosis right?

I have another Doctor on staff - the shiny red metal you see in the above picture, Dr. Copper.

Your humble scribe has been espousing the merits of this commodity as an indicator for some time now, and the move to new highs recently has been unsurprising to me. As a consequence of the massive stimulus aggressively supplied by global central bankers this year, a 'rally of everything' has unfolded. Copper is just one of many assets benefitting from their unprecedented reflation strategy. But does that mean that the good doctor has made the right diagnosis? Is the economy truly out of the woods?

Most doctors rely on two key pieces of evidence. Family history and diagnostic tests.

To diagnose accurately, there is usually some degree of corroboration between the two. In the case of the economy, we know the history. An easing by central banks causes a steep yield curve, which liquifies the banking system, which engenders lending for an economic expansion. We now need to do some tests in order to confirm the economic recovery that copper seems to be predicting. Think of it like blood work, only less painful.

It's Chart time!

COPPER/GOLD RATIO - 2YRS

Well, I rest my case on this indicator. A more definitive breakout is hard to imagine. If this was a PSA reading you'd freak out! Last month's capitulation in gold by the perma-bear 'risk-off' crowd was palpable (read last week's "Bug Killer"). Combined with the rapid ascent of copper, the indicator is unambiguous in confirming that a successful reflation has begun. And the positive fundamental case for reflation has been suddenly accelerated by the announcement of multiple ultra-effective vaccines. So, what does this indicator look like longer-term?

COPPER/GOLD RATIO - 40 YRS

I have circled the major inflection points in red. At every one of these inflection points, monetary authorities eased policy in response to deteriorating economic conditions and/or market distress events such as the 1987 crash or the EM crisis in late 1998. This year has been no different. The subsequent outperformance of copper to gold has more room in terms of duration and magnitude if history is our guide.

The biggest surprise in the reflation story is the renewed role that China is playing. Most news reporting has focussed on the damage to the domestic service sector - most notably restaurants and travel. Lost in this is the fact that China has recovered more dramatically than most countries mostly due to the command & control nature of their governance. The lack of personal freedom is actually a strength in this situation.

In response to their infrastructure focussed new 5-year plan, copper imports have surged recently on expectations of strong demand. All this at a time of some temporary COVID-related supply curtailments.

CHINA COPPER IMPORTS

The bull case is now the consensus. The hoped-for rotation to value and the catch-up trade in commodities has fuelled a level of optimism that has quickly become embedded in investor expectations. Dutifully, the financial players (Hedgies & Macro Funds) are loaded-up. The latest 'Commitment of Traders' report from the CBOE has soared to new highs in terms of speculative positioning (below). All of us are tired of the pandemic and want it to be over. Certainly, the recent behaviour of cyclical stocks and commodities, including oil, would argue that, for investors, it already is.

COTR FUND POSITIONING

A quick check of Google search trends shows that the term "Copper Stocks" has surged in terms of search activity. I fear that the FOMO trade has now infected the copper markets. The popularity of the trade is now a possible Achilles Heel for investors. My 'gut-feel' call is to take profits.

GOOGLE SEARCH: "COPPER STOCKS"

There are a number of opportunities for the copper market to pull back sharply, as has been the case in past early-stage recovery rallies. The Chinese are notoriously savvy commodity traders, often commanding their SOEs to abruptly reverse course and cease purchases when markets turn frothy. The hoped-for fiscal stimulus and infrastructure spending in Biden's 'Build Back Better" is likely to be delayed in the gridlock-prone Congress. And the promise of the "Green Economy" is a wildly premature theme in terms of actual physical demand. The hype about EV is way ahead of actual adoption given the current level of market penetration near 1-2% globally. Tesla is still a concept stock in my view, despite its apparently reluctant S&P500 inclusion. We may have finally reached 'Peak Musk' as the last shorts cover into the artificial, temporary demand from passive funds adding the name.

For another example, Freeport McMoRan has been in a parabolic rise from the summer lows and is now 70% above the 200 dma. The RSI is extreme at 80, and the MACD momentum is starting to non-con the new highs. I think the pull-back potential is elevated.

Freeport McMoRan

The year-end melt-up that is shaping up is not a time to rush into the market with the last remaining unrisked cash. That will only end in tears - most likely frozen ones in January. Anecdotally, I am getting stories from veteran investment advisors worrying about their client's behaviour. Some are taking money from the conservative hands of experienced managers to chase the momentum trade.

I'm also hearing that Uber Drivers are long copper now.

The diagnosis from our good doctor is likely correct in the long term. I just think a second sober thought should be given. Sell on news!

Shortly we will see the first needle that injects the COVID vaccine. I fear that it may also pop the crowded "re-opening" bubble. The doctor will see to that. Watch Dr. Copper closely.

Risk Model: 3/5 - Risk On

The price variables in the Model (RSI > 60 & 200dma 10%) are flashing a warning that has yet to be heeded by the market. As we are now wrapped up in the vaccine rally, there is an elevated risk of overshooting despite the positive messages from AAII, VXV and Copper/Gold.

If bonds are saying more than just "QE" - stocks may be asking for trouble.