Copper Versus Inflation: Both Going Higher?

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Includes: CPER, CUPM, JJC, RINF
by: D. H. Taylor

Summary

Inflation and copper have a strong correlation.

The Federal Reserve has printed massive amounts of paper via their QE programs.

As that paper works its way into the economy, copper will go higher.

With all of the paper printing that the Federal Reserve did during the Great Recession eventually we will see that seep into the economy. I believe the time for that to happen is now. I also believe that there are going to be large moves in metals, specifically, copper.

I wrote last week regarding metals and their inflation correlation, and that if the inflation we have been seeing is going to push the price of metals. My view stemmed from this chart showing gold and the U.S. inflation rate:

Gold versus Inflation, United States

I wanted to continue with this thought despite the market largely remaining flat the past week.

I looked at many different charts comparing copper and certain economic indicators to determine if there was a "leading" indicator that would show how copper may be moving.

First, generally overall, I am bullish on the economy of the United States. But, I am looking at variables today, discounting any potential future "Tweets".

The U.S. consumer is earning more and spending more, with year-over-year growth rates at 3.8% and 4.3%, respectively. As the rate of growth in incomes increases, so does confidence and expenditures. Then, businesses need to kick in to meet demand. No new ground broken there. Please note, in my analysis I always start with the consumer since they are over 70% of the economy; consumers have a far bigger impact in starting, or stopping, the economy.

The strongest correlation between copper and any other chart I saw was versus Industrial Production. Industrial Production is a lagging indicator since after the initial expenditures it takes time for businesses to ramp up and order supplies. Likewise, prices are a lagging indicator. There needs to be continued demand and shortages of supplies to push prices.

That being said, Industrial Production has just gone positive on a month-over-month basis after being negative for several months, and has been trending upward from its recent lows. This is a trend that I think will continue.

There may be an 8000 lb. gorilla in the room, as I have written about China. I see the potential of something very dark with their economy. In the meantime, copper and China's IP follow the same trends:

In fact, some would say that the correlation between copper and China's IP is closer to a perfect 1 than the United States' correlation factor. That may very well be true. But, the gorilla may be sputtering which disconcerts me a great deal and I am going to be vigilant in watching that. China consumed as much industrial products as making could produce and were a major factor in pushing up the prices of these. However, their IP has bottomed out and potentially it may be about to capitulate.

In the meantime, I see the U.S. economy continuing to expand. I see the consumer moving forward in many ways. Eventually, semi-employed will be looking to improve their disposition with their incomes to keep up with the prices of things they don't pay for, such as food and gasoline, inflation versus core shown:

Also, there is a correlation between the price of copper and inflation, albeit lagging:

If the U.S. consumer is beginning to earn more and spend more, and business production is starting to turn to the upside, then overall prices are going to do the same. All else equals, I see the economy expanding and I see the price of copper increasing as the economy moves forward; copper is going to catch up to the inflation rate quickly.

But, the real issue is all of the assets that were created during QE; there were four. Here is a chart on the Federal Reserve's assets that they hold starting from a few years prior to QE:

The Federal Reserve themselves do not actually do the "money creation". Instead, that stems from the member banks matching the purchases of the assets that the Fed makes. The Fed themselves are going to be orderly about their removal of QE. However, keep in mind the main purpose of the Federal Reserve: they maintain order among the banking system. If banks were actually responsible they would rein their lending in as soon as the economy began to heat up. But, banks respond to their bottom line. To drive home a point, if banks were actually responsible there would have never been a financial meltdown to begin with.

My best guess is that while the Fed begins to pull in the excess capital in the system the banks will initially be doing the opposite; they are going to lend as quickly as their bottom-line driven hands can process paperwork. That will create paper. This past month saw a year-over-year increase above 7%, a number considered above-trend. That 7% is off from recent highs as high as 10%. I will be watching this vigilantly.

We are still very early in economic growth with this economy. The Republicans are threatening a tax cut. I am thinking it may take far longer to implement. I agree that our corporate tax cut to rates that are a lot closer to the rest of the world is merited. I do not agree that tax cuts pay for themselves. That just seems like a cheap bumper sticker slogan. In the meantime, private Debt/GDP has increased from last year to this year very modestly. If that starts to take off, things could get ugly.

For now, just like the Fed, I see economic growth increasing. With that, inflation should continue upward. Given the paper problem, the question is how far can inflation go and how fast does the Fed have to move. But, given the correlation between inflation and metals, I am bullish.

Currently, I am long a risk/reversal on gold with short puts at $1,100.00 and long $1,350.00 calls. If I continue to see IP move higher in the United States then I am very likely to put on additional metal trades via copper. Right now, I need a bit more evidence before I pull the trigger. Next week, we get Durables and ISM Manufacturing in the United States, Monday and Wednesday, respectively. If these numbers are positive, which I fully expect, I am going long copper.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in COPPER over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.