“Every bull market has a copper top”

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“Every bull market has a copper top.” - Old Wall Street Adage

“Does she or doesn’t she?” was the question posed by Clairol ads in the days of yore. Nowadays the most popular question posed by the financial media is, “Will they or won’t they?” The “they” in question are the members of the Federal Reserve Board and the “will or won’t” refers to action taken to taper or eliminate the current round of Quantitative Easing – some $85 million per month in purchases of government and mortgage-backed securities. On September 18 it was announced that “won’t” is the operative word, at least until the October meeting.

In times even more olden than the Clairol ads, Groucho Marx hosted a television game show entitled, “You Bet Your Life.” At the start of every show a “secret word” would be revealed to the audience. If one of the contestants mentioned said word on the air, they would win $100 – a not inconsiderable sum back in the day. The word “won’t” had a similar salutary effect on September 18 as the Dow rallied to a new all-time record high. As we noted in our last missive, this “junkie” stock market quite likes its monthly monetary “fix.”

Once the news was out, however, the market closed the month by selling off in seven of the last eight trading sessions. Earlier in the quarter stocks had rallied into early August and then had fallen back in a Dog Days correction before the rally to historic highs commenced. It seems that 15,000 has been something of a magnet for the Dow of late, much like 12,000 was way back in, um, last year. In any event, the net for the quarter was a 1.5% price gain that brought the year- to-date return less dividend reinvestment to a handsome 15.5%.

“Won’t” in this context, of course, is a four-letter word for the crabby sorts over in the fixed income sector who much prefer hard money and hard times. Hence, the misanthropes pushed market interest rates higher despite the Fed’s intention to keep them low. This was, however, insufficient to deter Verizon from bringing to market the largest corporate bond offering on record – a whopping $49 billion that was almost three times larger than Apple’s $17 billion issue in April.

Commodity prices rallied during the quarter and produced a 3.6% return, thereby dwarfing the results in the financial sector. A possible fly in the ointment was that commodity prices did not rally back to record highs as stock prices did. In fact, most commodity prices topped out two years ago – a subject that we shall opine upon anon.

Once again the revisionist historian Beltway bean counters have changed the past. Back in April they told us that first quarter GDP growth was an annualized 2.5%. In July they informed us that, no, it wasn’t 2.5% but 1.1%. Hmm. At the same time they announced that second quarter growth was 1.7%, a number that has since been revised to 2.5%. Yet again we say “hmm” because those percentage errors represent a heckuva lot of beans. Maybe they should consider a name change from the Bureau of Economic Analysis to the Lost and Found Department. And to think that the financial press is bemoaning the fact that the government shutdown is depriving them of more of this quality data. For our part, all that we will miss is the comic relief.

Some of the other, uh, data indicated that a rebound in production occurred late in the quarter after a bit of a slump in the spring. This appears a bit curious given that personal spending has been pretty weak of late. Then again, a large part of that upward revision to second quarter GDP was accounted for by an increase in inventories. That typically is not a good thing unless consumer spending is on the verge of an upturn. Alas, that doesn’t appear to be very likely. Despite the elation on Wall Street, Main Street is still feeling some pain as personal income growth has been meager and sentiment measurements are reflecting consumer reticence.

There may be a ray of sunshine in the offing, however, as initial claims for state unemployment insurance benefits have recently fallen to multi-year lows. This is an important leading indicator for both the jobs market and the general economy. The $64 question (yet another prehistoric game show) is whether this decline is the result of a bona fide cutback in layoffs or if instead it is reflecting the declining labor force participation rate resulting from job seeker frustration.

In the sporting news, the Cubs should consider changing the name of their stadium form Wrigley Field to The Revolving Door as dozens of different players were shuffled in and out of the lineup during the season to no avail. The string of consecutive years without a World Series appearance has now stretched to sixty- eight. The only solace is that their woeful 66-96 record was actually three games better than the crosstown rival White Sox’s. Pale Hose, indeed.

These pages have long noted the importance of commodity prices as leading indicators; hence, the market adage cited earlier. Our praise for market- determined indicators stands in sharp contrast to our disdain for statistics provided by bureaucrats. Copper has been hailed as “the metal with a Ph.D. in Economics” because the trend of copper prices historically has peaked before business cycle downturns and turned up before economic recoveries.

We bring this up because, as noted heretofore, commodity prices, including copper, have not achieved new highs this year despite many stock indices having done so. In fact, copper topped out in 2011 just under the $4.50 per pound level and recently has been trading just above the $3.00 level that appears to be an important support area. Given copper’s history, one would presume that stocks are at or near a peak from which a correction of at least moderate proportions might be expected.

To this we say, maybe, maybe not. Two years is an awfully long lead time and makes us wonder if some sort of disconnect has occurred. Although there are a number of reasons to suspect that a stock market correction could be at hand,

there are also reasons to question that copper’s efficacy as a leading indicator may be waning. The deindustrialization of America has been occurring for several decades. Ours is now a predominantly service-based economy wherein industrial commodities like copper have reduced relevance.

A close look at what is called the Dow Jones Industrial Average is revealing. Last month the venerable index was revised with Goldman Sachs, Visa and Nike being added while Bank of America, Hewlett-Packard and Alcoa were deleted. Following this change, thirteen of the Dow’s thirty components are either service-based, retail or financial companies. There are only maybe ten or eleven companies left in the Dow that are consumers of copper in any significant way.

Does a metal that appears to have a greatly reduced relevance in a post-industrial economy have any relevance as an economic indicator? Perhaps less so than in the past but we are not quite ready to entirely dismiss copper’s puissance. It certainly is relevant for China, a place where stuff containing copper is still being made. This is important because the Chinese hold an enormous amount of U.S. government debt paper. If China catches cold, there is a chance we could get pneumonia. Furthermore, the Chinese banking system is, if anything, more highly leveraged than our own was before the late unpleasantness. Hence, should copper drop significantly beneath the $3.00 support level, it might be a good idea to look for a solid piece of furniture under which to duck.

- Weaver C. Barksdale, CFA