Diary of a Financier

From the Trading Desk: Trade Reconciliation (Week of October 24)

In Trading Desk on Sun 30 Oct 2011 at 09:55

In evaluating long positions this week, I considered joining the rally by adding to my preexisting longs and adding some new positions. In the end, I determined most composite components look overbought short-term, bullish intermediate (the weakest determinism, in my experience), and bearish long-term. I’m left awaiting a pullback and better entry points.

Yes, I still await near-term travail from Europe. I fully expected the month-to-date rally, yet I openly chose not to double my equity exposure–opting instead for focus on the “big picture” and prudent risk management. This rally–particularly this week–has tortured my patience. Still, the alignment of the stars recommends I maintain self-control. Through weeks of Eurorumors, we’ve been able to behold the pyrotechnic spectacle of short covering in all markets, a parenthetical victory for the Eurocrats.

I have a story to tell; it lends credence to my skeptacism…

Having sat on my bench almost all year now, Freeport McMoran (FCX) was one of the nominees I evaluated for inclusion in our portfolio this week. I revisited this copper & gold miner because I notice it has underperformed even physical Copper (HG/) since this summer. I love hard asset trades. If I could own any business in the world, it’d be a raw materials business like Copper. I’m reminded of Francisco d’Anconia from Ayn Rand’s Atlas Shrugged when I say this, but materials businesses like FCX are a powerful steward of wealth; not just any wealth, but wealth you can rest-assured will pass from generation to generation. With the precious metals/commodities trades having corrected now (some more than others), I have the opportunity to purchase a business like FCX at an effective discount for clients, who can conceivably pass the asset onto their heirs. (The notion is common, but Barton Biggs dwelled on it in Wealth, War & Wisdom too.) In the end I refrained from buying due to a poor technical setup, despite an attractive valuation. I will engage FCX eventually. For now, it turned my attention to an important development…

Everyone knows about Copper’s historical significance as a leading indicator–something I’ve highlighted here on occassion. Copper truthfully conveys more economic than stock market connotation. Note the important distinction between economy and market. Historically, they do often exist in tandem, yet behind every healthy stock market is not necessarily a healthy economy. The last two years have offered one such exception, wherein a bifurcation opened between the surging market and sputtering economy. Copper wouldn’t have any of it, forging onward & upward with the market. Emerging Market (Chinese) demand helped HG keep pace with global equities, while Developed economies flatlined.

Of a sudden (not a surprise for some), Copper led stocks down from a precipice this summer. As the S&P 500 (SPX) recovers a bit from that decline, Copper has been left relatively lowly. Before I drop this week’s Trade Rec, I wanted to spotlight that divergence, which I had mentioned in a StockTwit on Friday:

$HG_F still far fm retracing losses, lagging $SPX by a lot. HG 20pc fm hi, 5.4pc fm 3q11 sppt. SPX only 6.7pc fm hi, past sppt.

Let me illustrate the recent Copper/Equity divergence in the charts:

HG v SPX- Copper lagging the “recovery rally” by a lot.

Who is lying? At this moment in time & space, are stocks exuberant or is Copper too tentative? I certainly give Copper the nod. HG provides a real-time proxy for economic activity, as opposed to the backward-looking economic data reported almost every business day. Even if I’m right (if HG is right), the stock market can hide its despair for longer than anyone cares to reveal it. I’m looking for cues en route to the truth. Beneath this cue, I find truth, a truth no government (this side of Euroreckoning) can sweep under the rug.

~~~~

Without further ado, refer to the Trading Desk for this week’s Trade Reconciliation.

–Romeo

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