What copper whispers in my ear?

From Gareth Stokes, MoneyWeek editor, SA

Dear Money Morning reader,

It’s almost impossible to predict a direction for equities these days. Shares on the local exchange seem to be priced in sentiment and uncertainty, rather than value and forecast earnings. In the first three weeks of March, the JSE All Share Index surged 3,302 points to post a 15.4% gain, prompting talk of a market turnaround. But since then, repeated 1,700 point seesaws – between 21,500 and the late 19,000s – have savaged investors.

Each sign of an economic recovery is countered by a raft of negative statistical data, with the market turnaround tag quickly replaced by talk of a bear market rally. It’s clear the global credit crisis isn’t ready to be confined to the history books just yet.

Perhaps we’d be less surprised if we paid closer attention to the real world…

We should forget the raft of statistics the economists quote on a daily basis and spend some time assessing supply and demand for the critical building blocks of an economy. One way to do this, is to foster a deeper understanding of the link between the market for base metals and prospects for global growth. When demand for steel, aluminium and copper – identified by the US Geology Survey as the world’s top three industrial metals – is on the rise, then so is GDP. When demand slumps, we can safely say prospects for global growth is limited. And when it slumps for a long period of time, we know recession is upon us.

Let’s use copper as our economic pointer and back-test this hypothesis. The best indication of the balance between copper demand and supply is its price, and a great proxy for the copper price is locally listed Metorex (JSE:MTX).

In November 2007, shares in Metorex were changing hands at close to 3,000c. Investors were riding the commodity boom to its fullest – chasing the price of anything that dug holes in the ground to new highs.

But over the next three months (November 2007 to January 2008), the copper industry stuttered. Metorex almost halved to 1,500c as investors headed for the hills on concerns for the US economy. Today – armed with hindsight – we know this dip coincided with the US economy entering recession.

But South Africa was slow to appreciate the shifting sentiment in the developed world. Overzealous investors rekindled the commodity sector through the first half of 2008 with heavyweights, like Anglo American and BHP Billiton, pulling the entire index higher. Investors were oblivious to softening conditions in banking, financial and retail shares because of the country’s huge commodity bias. The commodity bubble burst when the extent of the global financial crisis became known – and plummeted further when economists started talking about recession. Copper was particularly hard hit as prices fell from a record $8,940 per tonne to less than $3,000 per tonne in next to no time. And Metorex slid from north of 2,500c to south of 200c in sympathy.

What does today’s copper market tell us about the future?

Bloomberg (on 22 April 2009) said the base metal endured its steepest three day decline since January. The reason: “Speculation that the global recession will deepen and cut raw-materials demand!” Worse news comes in the form of an International Copper Study Group report. It suggests refined copper stockpiles will grow until “at least” 2010. With supply exceeding demand by some margin, we must conclude we’ve yet to experience the full fury of global recession. Under these conditions we’d avoid the base metals sector for at least 12 months. If you’re prepared to wait until late 2010 for the expected turnaround, then add something like Anglo American (JSE:AGL) to your portfolio; but buy on dips to nearer the R150 per share mark.

For those who’d rather give base metals a wide berth until the recovery’s underway, an entry to the gold mining sector is a better option. Although risky, we expect companies like Harmony Gold (JSE:HAR) and Gold Fields (JSE:GFI) to produce solid earnings through 2009 on the back of high rand gold prices. These counters should outperform as sentiment drives punters back to the safe haven of gold.

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Turning to the markets...

The JSE all share index closed down 1.46% yesterday. The gold mining index lost 1.18%. Resources tumbled 0.73%. Banks and financials plunged 3.67% and 2.58% respectively. Industrials fell 2.02% and the platinum mining index shed 0.3%.

London’s FTSE100 closed up 1.08%. The Dow Jones plummeted 1.04% and the Nasdaq gained 0.12%.

Tokyo’s Nikkei closed 1.53% up. Hong Kong’s Hang Seng added 0.90%.

Brent crude is currently trading at $49.66 per barrel.
Spot gold’s trading at $891.90 and platinum was last quoted at $1,167.

And here’s how the rand is performing against the major currencies:

R/$ 8.91
R/£ 12.98
R/€ 11.62