Right, so there’s been no shortage of commentary on China and commodities recently.
More specifically, there’s been no shortage of commentary about how Beijing’s efforts to rein in speculation may be contributing to metals mayhem by effectively acting as a margin calls. As RBC’s Charlie McElligott wrote last Thursday, the combination of higher money market rates and Beijing’s crackdown on shadow lending is “acting as ‘margin call’ on ‘commodities as collateral’ financing trades.”
Simple put, leverage run wild in China’s shadow banking system has demonstrated a remarkable (and exceedingly unnerving) propensity to inflate bubbles all over the fucking place – bubbles that subsequently burst at the first sign that conditions may be tightening.
Given that, it’s probably fair to ask if some traditional relationships between the assets that are subject to the shenanigans outlined above and economic trends still hold.
Well, that’s exactly what Bloomberg’s Cameron Crise set out to do with “Dr. Copper” who he thinks “should be sued for malpractice.” More below.
Traders love a good overlay chart that helps them spot divergences between economic and market variables. Yet an overreliance on simple heuristics can be dangerous, particularly when one of the variables isn’t measuring what you think it is.
- Comparing different time series to spot divergences (and thus investment opportunities) is a staple of macro trading. Implicit in the use of the technique, of course, is confidence in one’s ability to know which variables are independent and which are dependent.
- An example of such an overlay is a comparison of the U.S. 10-year yield and the copper/gold ratio. Based on the relationship of the last few months, it looks like yields should be about 20 bps lower.
- Intuitively, this makes sense. Not only does copper reflect input costs and thus inflation, but it is also a famously accurate indicator of the economic cycle — hence the sobriquet “Dr. Copper.”
- In these days of rampant commodity speculation in China, however, can we really trust copper to give us an accurate read on the U.S. economic cycle? After all, it’s not altogether clear why microeconomic tightening measures in China should impact U.S. consumer demand, for example.
- I looked at monthly changes in copper and the Chicago Fed National Activity Indicator 3-month average, a useful proxy for economic activity. While historically there has been a positive correlation between the two series, over the last year and a half or so it has actually been negative.
- The relationship looks the same when comparing copper to quarterly GDP growth. Historically there has been a positive correlation; more recently, however, it has turned a little negative.
- While it seems likely that price action in industrial commodities is telling us something, it doesn’t appear to have much to do with the U.S. economic cycle. As such, trading bonds based on divergences with the copper price would appear to be a dubious proposition.
- Perhaps Dr. Copper needs to go back to school and defend his PhD thesis to the market.