Daniel Moser's  Instablog

Copper has had one hell of a run.  On October 20^th, I wrote a post for Seeking Alpha arguing that even if copper did not break through the $3/lbs. level, mining stocks would be able to fair just fine.  My argument is relatively simple and straight forward:  with copper prices significantly above even the producers with the highest marginal cost of production (somewhere between 90 cents to 1.50/lbs.) copper miners can earn an excellent return on invested capital.  So long as copper prices remain strong (notice I did not say 'keep climbing'), copper mining companies should continue to drift higher and I would expect them to outperform the general market.

Some recent data put out by Barclays indicates that the supply of copper is expected to increase by 8% in 2010.  This would undoubtedly be a significant headwind for the price of copper to overcome, if it were only true. 

Global Macro View for Volatility in 2010:  What should investors make of the exceptionally steep yield curve coupled with the level of stock market volatility, as measured by the VIX index?  Back in June, I wrote an article on Seeking Alpha calling for investors to short volatility.  Since then the VXX (volatility ETN) has fallen from 75 to 42.5 or by approximately 43%, as the VIX index fell from the 50% range to the low 20% range.  Where do I think the VIX is going from here?  Applying the same analysis as what I posted back in June would lead to the same conclusions–short volatility represents a compelling opportunity.  However, I don’t believe shorting volatility represents quite the same risk/reward as it did before.

 

In this case, I believe the risk/reward scenario actually points to buying volatility at certain levels.  In my opinion the market is inherently unstable.  Going into 2010, the global economy/market is being bolstered by massive amounts of government stimulus.  In addition to massive government spending, central banks around the world have engaged in outright market intervention by practices such as quantitative easing.  Although we can argue about the timing of the exodus of government stimulus, surely we can agree that sometime during the second half of 2010, several governments (if not the majority of governments throughout the world) and central banks will begin withdrawing the stimulus capital as well as slowing down or outright halting intervention in the fixed income markets.  At that point we will really see if the global economy can stand on its own two feet.  The temptation to quote a personal hero of mine, Dennis Gartman, is just too overwhelming for me to resist. Dennis Gartman recently said, “Investing is rather like the children’s game of ‘Musical Chairs.’ We must dance while the music is playing, knowing full well that when the music stops we shall all be dashing for the few chairs that are there to be taken and we shall fight for them when that time comes, but while the music plays…while the flute is up to the musician’s lips; while the bow is being pulled across the violin… dance we must, or sit out the game on the sidelines.”

Dennis Gartman is really on to something here.  In this instance, there is a ton of uncertainty in the market place, and quite frankly rightfully so.  The more I think about it, the more I think 2010 could be a range bound year for volatility.  I can’t really see why the market should average less volatility than the 20-30% range, as seen from 1997-2003, given the vast amount of serious issues, policies, and questions that will remain through 2010.  Would I outright short volatility at this level?  No.  Would I buy volatility instruments such as the VIX between 20-23% or the VIX ETN (Ticker: VXX) between 40-42/per note…absolutely. 

What should investors think about copper just under $3/lbs?  In my opinion investors (even those more short term trading oriented) should not freak out if copper fails to break above $3/lbs.

Salida Capital, one of my personal favorite global macro investment firms, did some work a few months ago on copper with respect to Chinese buying patterns.  They argued that, “China’s import pattern over 2004–09 also indicates a noticeable price sensitivity, although the key level appears to be US$3.00/lb. While that price is above today’s level, we would note that the current supply/demand situation is markedly different than in recent years. As such, we would not be surprised if China’s discretionary price level has been lowered as a result. After all, the country knows full well it faces a buyers’ market — and it is the only major buyer.”

http://www.salidacapital.com/admin/media/uploadedFiles/SalidaCapital_CautiousOnCopper...ForNow_Jun_25_2009.pdf

Presently, copper prices are just under $3/lbs. which makes this analysis extremely relevant.  If Salida is correct in their assessment, Chinese copper imports might begin to slow until the price of copper corrects a bit.  Although, imports have remained extremely robust and so long as relatively decent importing continues copper companies should be poised to do very well–even if the price of copper can’t crack $3/lbs.