Boom Sayers Part Two

Signs of the Times

Last Year:

"You can't stop the master metal [copper] from rising."

~ Financial Post, February 19, 2011

"Soaring Food Prices"

~ USA Today, March 18, 2011

"UN Food Index at Highest in 20 Years"

~ The New York Times, April 12, 2011

"China 5-Year Plan: All prosperity to the People"

~ Economy Watch, April 6, 2011

This Year:

"Codelco Boosts Investment, Sees Tight Copper Market"

~ Reuters, March 6

"Managed Funds Raise Bullish Copper Bets"

~ Wall Street Journal, March 16

"The Long Good Buy; the Case for Equities"

~ Goldman Sachs, March 21

Is the latter equivalent to "DJIA: 36,000!" of 1999?

Not likely, and bullishness is due to valuations relative to bond yields. The latter may not stay benign "forever".

Perspective

Last year, "they" were wringing their hands and tearing their hair about soaring food prices and pending shortages. The chart of the FAO Food Price Index is shown below. It seems that the excitement of 1Q2011 was the culmination of the rise out of the crash that ended in 2009.

Another view is provided by the GKX (agricultural prices). The cyclical high of 2008 was 513 set in that fateful March. The subsequent low was 245 in late 2009. On the business cycle out of the crash, the index reached 570 in March a year ago, which we took as another cyclical high. The next low was 245 in December.

The rebound into the first quarter could have been stronger, but in the last month the action has been a modest uptrend. So far the high has been 450, but without much momentum. No technical decisions on this sector.

Base metal prices have been more dynamic, with the GYX setting what we considered as a cyclical high of 502 in March last year. Of importance, is that this was part of the speculative surge in commodities likely to complete at around that fateful March-April. This was based upon our Momentum Peak Forecaster.

As Mother Nature has long decreed, base metal prices are cyclical and so are mining stocks. Often at lows or highs, mining stocks (SPTMN) will lead the turn on metal prices. That was the case at the top last year.

This year, the SPTMN set its high early in February and, as of this week, has set a downtrend. Metal prices (GYX) set their high later in February, but have not rolled over.

A headline at the end of January was "French Auto Market Collapses". Last week it was "Car sales in Western Europe are now falling at their fastest rate since mid-2010". That described the February number.

Comparisons to 2011 are interesting: Base metal mining stocks led the high in metal prices again. Of critical significance is that both reached similar momentum peaks with similar anecdotal enthusiasms - but at lower price levels.

The high for SPTMN in 2011 was 1600 and similar momentum and anecdotal enthusiasms could only drive the index to 1258. Rebounds, since, have been weak, and today's slump to 1051 extends the downtrend. Taking out 1013 sets the glide path back to the October low of 752.

Much the same applies to metal prices with the GYX high at 427, which compares to 502 in February, last year. Today's drop breaks a wedge pattern and the trend is down. At 396, taking out 395 would confirm the trend change. An interim target is December's 356.

This action confirms that 1Q2011 set a cyclical high for base metal prices and mining stocks.

This is also confirming the worth of our proprietary Momentum Peak Forecaster. A one-pager summary was published in our May 19th edition and it follows.

Forecaster

May 19, 2011
Commodity Speculation and Recessions

• The reversal in the Forecaster to down provides the signal.
  

• Typically, the peak of speculation has been associated with the test of the reversal a couple of months later.
  

• The initial reversal was set in November 1979 and the test was completed in January 1980.
  

• The initial reversal occurred in January 2011 and the test completed at the end of April.
  

• Eventually, the recession will have been decided to have started around now.
  

Recently, we noted that a recession seems to have started in Europe in the middle of last year. But the past few months of joyful economic numbers in America indicate that the melancholy condition has yet to arrive.

However, on 33 business cycles since 1854, the NBER notes that the average expansion has been 42 months. This - the first post-bubble expansion - is at its 42nd month.

We don't often stray into the imaginary world of interventionist economics, but hey, there was the opportunity for a "call" on their unique world.

We prefer to identify market opportunities of an intermediate nature, which sometimes turn into cyclical moves.

Credit Markets

The early warning on a potential change in credit conditions can't be found in studying FMOC minutes. For us it was that the price-rally in the dreadful sub-prime mortgages stopped four weeks ago. Also, that's when the Ted-spread stopped narrowing.

Also in the middle of February, longer maturities such as municipal bonds (MUB) suffered a two-day hit that effectively ended the outstanding run that began early in 2011.

Then, with the Greek problem fixed markets were relieved of worry. Then, complacency hit a brick wall last week as sovereign debt yields turned up.

On the longer term, which still merits everyone's focus, post-bubble credit contractions have never been "fixed" by throwing more credit around.

And when there is confidence or complacency in corporate credit markets into the spring, we become wary of the seasonal change to widening that can happen in those fateful Mays. One critical one was in 2007, another was in 1929.

Generally, US spreads could churn around through April when the action could become vulnerable to the usual change. European sovereign stuff could become troubled sooner.

Spain

On March 28, 2007 Ben Bernanke boasted: "The impact on the broader economy and financial markets of the problems in the subprime markets seem likely to be contained."

Bob Hoye

Institutional Advisors

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