JJC: Too Correlated to SPY?

| About: iPath DJ-UBS (JJC)

Co-authored by Kristina Nissen

The holy grail of investing is finding assets that have a high-expected return with little to no correlation to each other. As we move deeper into a globalized economy, emerging markets such as China and Brazil will continue to outpace US production to meet local and global demand. Copper has historically moved in direct correlation with industrial production, making this heavy metal a reasonable proxy for global demand.

Why do you care? Main street investors need a way to access vehicles that directly express production versus corporate earnings. Currently, there is only one vehicle out there that attempts to track the price of copper. iPath’s DJ-UBS Copper TR Sub-Index ETN (NYSEARCA:JJC) may be a potential addition to a strong, risk managed, and diversified portfolio. We want to look at why copper is important to investors, how to incorporate it into an investment strategy, and the big picture risks of pursuing copper in a portfolio.

As a pure commodity, copper is fundamentally different than other investment vehicles in that it moves with the actual demand of industrial producers. Meaning, people need to use it in order to make things. Stocks on the other hand move in a direction based on the future expectation of earnings. Obviously, both stocks and commodities can experience short-term frenzy and rampant speculation, but in the end fundamental supply and demand wins out. This is why we need to consider the raw commodity versus a publicly traded stock. Copper is a pure investment that is based on the underlying demand of the commodity.

Therefore, as investors seek a pure play on global growth, commodities may be able to strip out the earnings risk of manufacturers or producers. With the pure commodity, you no longer have the external risk of a firm being profitable or unprofitable. Also, as we saw in 2010, merger and acquisition plays can skew the price of stocks.

Taking the next step is simple. We only want to add new components to a diversified portfolio that do not statistically duplicate the current holdings. Meaning, why add new parts to a portfolio that simply duplicate risks or clutter up the screen? So, how does JJC measure up compared to basic investing vehicles like SPDR Gold Shares (NYSEARCA:GLD) and SPDR S&P 500 (NYSEARCA:SPY)? Since 2007, JJC has moved in virtually perfect correlation to SPY. GLD on the other hand, has virtually zero correlation to the ETF in the same time frame. What you should take from that is a clue to predict how the future price of copper will follow other asset classes in the short-term.

A simple regression analysis can confirm a steady moderate upward trend in JJC as well as SPY. Clearly as industrial demand has recovered from the 2008 crisis, JJC has followed along. While GLD and JJC had an incredible correlation in the past, it started breaking down in 2007. Gold remains in a volatile position as a hedge against depreciating fiat currencies; it is not a pure play on global production.

For the individual investor, the only reason to purchase copper is to sell it in the future. One could make the assumption that if industrial demand is to continue in the emerging markets, there will be more actual demand for copper than for stocks or gold. However, it should be noted that like any typical investment, increases in copper demand is not an organic guarantee.

In the long-term, JJC may be volatile. Outside of that, JJC is not physical copper, but a note issued by Barclay’s that is designed to track the price. While not our biggest concern, it should be noted you are essentially buying a bond tied to the futures market. You should not expect it to hold up in times of market crisis, and in fact, will reflect the mood of manufacturers during economic slowdowns. Keep in mind copper and the S&P 500 don’t always move together in the long term. Why? It is possible that organizations can increase earnings by decreasing production and vice versa. So, you get a world where firms can produce more profits by using fewer materials.

Ultimately, in the short-term JJC is following SPY. To investors, this is a trend worth noting as emerging markets such as China and Brazil try to significantly boost industrial production to keep their population happy and riot free. However, while copper is a pure investment that moves with tangible demand, as with any other investment there is risk. JJC is not recession proof, nor does it pay a dividend. You trade it for one reason: to seek other sources of revenue in a competitive global marketplace. Good luck.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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