Courtesy of Doug Short.
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And What Might the Copper Carry Trade and Plunge in Chinese Exports Be Signaling to Investors?
How likely is the market to continue higher from here? Despite everything the market inches up. Now either we are all amiss, and in face of those high winds we still see market being so resilient, which means the market will break higher and move decisively up, or next week it breaks.
Great question, and you frame it well when you reference the wall of worry the stock market continues to resiliently climb. It reminds me of a client in AR who always asks, “Yes, but where are you wrong?” Oftentimes I haven’t had a satisfactory and simple answer. But, today, I think I do. And I will keep it simple.
We know from observation that US Stock market buying and selling climaxes can occur on NFP reports. Case in point is the March 6 2009 NFP low. So, it is possible that the SP500 high at 1887.50 on Friday March 7’s NFP will be the final high to this bull market campaign that began five years ago on a March NFP report. We also know from observation that the SP500’s final thrust into March 24 2000 and March 7 2014 are exhibiting strong correlations in time and price. That is, the 19-22 day final thrusts both reached the 1.27 external retracement price target from their respective February lows. (See technical observations on charts below). So, I am looking at Friday March 7 as a potential buying climax. As such, I am willing to state that 1887.50 will eventuate into an intermediate term high for the SP500. Therefore, if the SP500 breaches 1887.50, I know I am wrong. That is as simple as it gets.
- But, even if I am wrong in the near term, the stock market is unlikely to move decisively higher from here. To move decisively higher from here, the SP500 would have to warrant further multiple expansion. Currently, the SP500 is trading at ~ 15.7x FY 14 earnings, a level that is higher than the multiple it had when the SP500 topped in 2007.
- I am using behavioral models from the March 24 2000 stock market bull market top, and the March 6 2009 bear market low to inform and guide us as to “how” the SP500 is supposed to trade on Monday (ex-Russian variable). The Y2K high says Monday should only trade ~ 1.50 higher than Thursday’s high of 1881. The Y2K high says then that the SP500 should find resistance above 1881 around 1882.50.
- The March 6 2009 NFP low was followed by a +5 point higher low on Monday March 9 2009. If we invert that bottoming model, that means that Monday March 10 2014 should find resistance near 1882.50, which is -5 points below the high set on Friday March 7 2014.
Summary (please reference technical observations on the charts below)
The key question I am answering for you on a technical basis, is how will/should Monday’s candlestick relate to the candle on Friday March 7, if Friday March 7 is to be “the high.” What sort of “structure” should Monday have if March 7 is the high? March 7 was certainly the “sit down” type of day that we were looking for in terms of “structure” on Friday (the “sit down structure” on Friday correlated well to the “sit down structure” on March 24 2000 and the “inverse structure” found on the March 6 2009 NFP low. So, now, will Monday also have the type of structure we are looking for to confirm whether Friday March 7 will be the high or not? (Caveat Emptor: Russia is a variable that can alter the type of structure I am referencing and looking for on Monday March 10.
) Anecdotal Chinese Copper Carry Trade Unwind Observations
A week ago, on March 2 2014, Forbes reported that NYSE margin debt hit a record $451 billion in January. With the higher highs set in February, we have to assume NYSE margin debt reached another record high in February, but that won’t be disclosed until the first week of April. Hindsight evidence (indicators) won’t do investors much good if the stock market is topping out now.
Record NYSE margin debt is likely to be related to “institutional” debt versus retail debt. Some sophisticated institutional investors sell Yen to buy equities and other risk asset classes. This is part of the Yen Carry trade. Yen carry trades generally work well as long as the Yen remains weak and the equity market remains strong. Evidence of “Yen carry trade unwinds” may be a “coincident indicator” that precipitates a potential reduction in NYSE margin debt.
But, there is no evidence of a Yen carry trade unwind as yet. And the problem with “coincident indicators” for the US stock market investors is that they happen concurrently with stock market declines, leaving the investor little time to react before it is too late. However, there is another type of carry trade unwind that may be a very useful “leading indicator” for equity investors. That is Chinese Copper Carry Trade unwind that we spotted on Friday March 7 2014, the same day that the US stock market may have been topping out.
Equity investors should consider taking the China’s Copper Carry Trade unwind seriously. Why? Because a reduction in copper demand can indicate a potential global slowdown looming. Thus, spotting copper carry trade unwinds can be a valuable “leading indicator” for global equity market investors.
How the Copper Carry Trade Works
China imports a lot of its copper from the LME. Much of this imported copper is used as “collateral” to finance investments in other risk asset classes as part of the carry trade. From Bloomberg on Friday March 7 2014: “Copper stockpiles tracked by the Shanghai Futures Exchange gained 4.6 percent to 207,320 tons this week, the highest in 10 months. On the LME, orders to remove the metal from warehouses slid to the lowest since April.” While anecdotal, I can not underscore enough how important this observation may be. Nor can I underscore how privileged I am to be able to spot the beginning of this significant carry trade unwind, rather than with the benefit of hindsight vision.
Copper futures crashed more than 4% on Friday in response to the copper stockpiling news. It was the largest one day decline for copper prices since August & September 2011, when the US stock market was last in the throes of a 20% correction. The copper stockpiling news on Friday appears to be a precipitating trigger to the next leg in “The Great Unwind” in Copper prices that first got underway in August 2011.
China is likely the largest LME customer in the world. Throughout last week, orders to ship copper from the warehouses slid to the lowest level since April. Yet somehow, copper stockpiles tracked by the Shanghai Futures Exchange gained 4.6% last week. Demand for copper by Chinese businesses and Chinese investors had to fall off a cliff last week for copper stockpiles to grow almost 5% in a week.
China has been preparing for several years to allow various malinvestments/businesses to fail. 2014 demarks the onset of debt restructuring reform policies in China. That is, the PBOC is no longer going to infinitely backstop malinvestments for which China is so famous for permitting. But now, China is going to allow some malinvestments to default. The first Chinese default began last week with a Shanghai Solar company failing to pay interest on its bonds. Coal companies are also expected to be allowed to fail later this year [reference].
The plunge in copper demand in China last week happened concurrently with a major Chinese company defaulting on its bonds. Coincidence? Maybe, but maybe not. It could be that investors have suddenly become disenchanted with their copper carry trades if the PBOC isn’t going to be there to backstop a lot of malinvestments.
Anecdotal Chinese Export Observations
And the narrative in China only deteriorated further this morning with Bloomberg reporting that Chinese “exports fell the most since the global financial crisis. Shipments dropped 18% from a year earlier.” Bloomberg cautions about putting too much emphasis on the yoy drop in exports because “Distortions in the data from the fake invoicing that inflated numbers last year make it harder to assess the true picture.” Nevertheless, GDP growth momentum is slowing in China, and export demand may be slowing just ahead of the US, Russia, and EU potentially igniting trade wars. If those trade wars between Russia, the US and EU eventuate, this will only exacerbate further the slow down in global trade over the near term. Meanwhile, a slowdown in Chinese export demand implies more Chinese businesses will fail than would transpire during a pickup in global trade and export demand. So, should it be any surprise that Chinese investors are suddenly unwinding their copper carry trades? [reference]
Please contact John at jb2@structurallogic2.com if you would like to subscribe to Structural Logic Research.
John Bougearel is a Chartered Market Technician CMT and founder of Structural Logic Inc., a registered Commodity Trading Advisor offering managed accounts for clients. Structural Logic Research publishes a daily financial newsletter for institutional and retail clients. John is a featured financial market educator for the ICE Exchange, Market Technicians Association, and various FCMs and IBs. John has authored two books, The Changing Role of Gold and Riding the Storm Out: What Do Investors Do Now. John is also a featured financial analyst on Bloomberg’s roundtable, Fox News, and other financial news networks. John received his B.A. from St. Olaf College in 1985.
(c) John Bougearel
