Monday, February 9, 2009

The Technical Take: Copper And Shanghai Stock Exchange Composite Index

Figure 1 is a monthly chart of a continuous copper contract. The "next big thing" indicator is in the lower panel; this indicator seeks to identify the potential for secular turning points.

Figure 1. Copper/ monthly

From the July, 2008 highs to the December, 2008 lows, copper dropped over 60% in value. It's fall has mirrored the global financial crisis and economic weakness. Over the last 2 months, copper is about 20% off its lows leaving investors to question whether the bounce is foretelling true economic strength - as in, the global economy is back.

The quick answer is, "No. This is only a bounce."

Copper stopped going down and found support at the old 2005 breakout levels. See point 1 in figure 1. This was a logical place for copper not only to find support (and stop going down) but to bounce as well.

The next big thing indicator is in the middle of its range (point 2, figure 1), and it is certainly not in a position that would indicate that a secular trend change is a likely event in the near future. Copper, like the global economy, will need time to "heal" or consolidate. Why is a period of consolidation important? My interpretation of a period of consolidation suggests that the forces of supply and demand are in balance, and a breakout from this range suggests increasing demand.

But let's think practically what happened to copper over the last 6 months of 2008. Copper lost 60% of its value in 6 months! What other subtle clues do you need to suggest that a secular trend change is currently at hand. In other words, a 6 month drop of this magnitude won't be reversed by 3 months of positive price action.

Figure 2 is a monthly chart of the Shanghai Stock Exchange Composite Index; the "next big thing" indicator is in the lower panel. This index peaked in October, 2007, and it lost over 60% before finding support and bouncing at the 2006 break out level (point 1, figure 2). Since those October, 2008 lows, the Shanghai Index is up 33%. The down sloping 10 month moving average (or approximately 200 day moving average) is only 100 points or 5% away. After the drop we saw this past year, what is the likelihood that prices will keep levitating above this key level? In my experience, this is not a high odds bet.

Figure 2. Shanghai Stock Exchange/ monthly

Lastly, let's take a look at figure 3, which is a monthly chart comparing copper (orange line), crude oil (black line) and the Shanghai Stock Exchange Composite Index (green line). China, which is the global growth story, is closely linked to these commodities; certainly growth in China would be reflected in demand for copper and crude oil, but only copper seems to be moving higher. If global growth is back, why is crude oil lagging?

Figure 3. Shanghai Stock Exchange v. Copper v. Crude Oil/ monthly

If I may steal a word from Trader Mark, who writes the superb blog "Fund My Mutual Fund", it is "thesis". Trader Mark always wonders what is the next "thesis" that traders will pile into for the next 20% gain. The global growth story is a great thesis, but according to the longer term charts, it is not a thesis that will have sustainable legs. That story is for another day a long ways away.


Mike said...

I want to thank you for sharing this very amazing post.

aldrin james said...

This post is just so informative. I still can't believe that things happen in Shanghai stocks. I will keep an eye on this issue.

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