An Ominous Sign From Commodities?

Martin Ritchie and Agnieszka De Sousa of Bloomberg report, Copper Poised for Worst Week Since January as Commodities Slump:
Copper traded near the lowest since 2009 as Chinese manufacturing data added to evidence that demand is slowing in the world’s biggest user of raw materials.

The preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics unexpectedly fell to the lowest in 15 months. Goldman Sachs Group Inc. predicts lower copper prices, and traders and analysts were the most bearish since May in a Bloomberg survey.

“China is very negative for metals today,” John Meyer, a mining analyst at SP Angel Corporate Finance LLP in London, said by phone. “There’s been a significant slowing of the economy. Construction and infrastructure spending has collapsed.”

Copper for delivery in three months on the London Metal Exchange fell as much as 1.5 percent to $5,191.50, the lowest since 2009. Prices are heading for a 4.3 percent drop this week, the worst loss since January.

Expanding gluts have pummeled markets for raw materials, with the Bloomberg Commodity Index dropping to the lowest in 13 years. Goldman Sachs says demand for copper in China, which consumes about 40 percent of the world’s supply, is poised for the slowest expansion in almost two decades.

While Goldman is bearish, Citigroup Inc. predicts copper will climb more than 15 percent by the year-end, helped by rising demand in China from consumer goods and the power grid.

Accelerating Demand

“We think that sustainable copper demand will accelerate,” said Ed Morse, head of commodities research at Citigroup. Prices are “approaching the lows, if not at the lows,” he said on Bloomberg Television.

Copper pared declines on Friday after data showed stockpiles in warehouses tracked by the Shanghai Futures Exchange fell to the lowest level since December.

The Chinese factory gauge was at 48.2 for July compared with a median estimate 49.7. Numbers below 50 indicate contraction.

“We have continued to see unrelenting selling pressure from Chinese investors, which has been the main weight on metals prices this week,” Nicholas Snowdon, an analyst at Standard Chartered Plc in London, said by e-mail. “A larger net short position from China’s investors is possible.”

The slump is driving down shares and increasing pressure on miners to trim costs. Freeport-McMoRan Inc., the biggest publicly traded producer of copper, fell the most in six months on Thursday after Chief Executive Officer Richard Adkerson told investors that “all options are on the table,” including asset sales and curtailing operations.

Macquarie Group Ltd. said July 16 that copper will find support in the mid-$5,000s a metric ton. Barclays Plc said this month that there was a floor at $5,000 and the metal had the greatest upside potential.

Nickel lost 1.2 percent, while lead and zinc fell more than 0.3 percent. Aluminum gained 0.2 percent.

“There are a lot of macro headwinds coming together to press commodities lower,” Francisco Blanch, head of global commodities research at Bank of America Corp., said this week. “I envision a few more months of commodity weakness.”
What are the "macro headwinds" driving commodity prices and shares to multi-year lows? The mighty greenback keeps surging higher as investors fear the Fed is getting ready to hike rates this year and more importantly, the bursting of the China bubble is why global investors are scrambling out of commodities and commodity shares and into good old U.S. bonds (TLT), which has the perverse effect of driving the USD higher.

All this spells big trouble for mining giants which are shedding thousands of jobs around the world. The devastation in commodity shares is unprecedented. The Bloomberg article above mentions Freeport-McMoRan (FCX) which is down 66% this year and keeps plunging to new lows (click on image):

And it's not just Freeport which is getting massacred. Check out the long-term chart of the S&P Metals and Mining ETF (XME) which is close to the November 17th, 2008 low of $17 (click on image):

You might be tempted to catch this falling knife but before you do, let me share a personal trading story. The week before Patriot Coal first declared bankruptcy, wiping out shareholders, I was trading it wrongly thinking they won't file Chapter 11 and making huge gains (+50% in one week). Then one day, BOOM!, they filed for bankruptcy and I scrambled to sell that big position for pennies.

If I remember correctly, that happened in the summer of 2013, right after I recommended a lump of coal for Christmas back in December 2012. That was a painful and costly mistake, one that taught me to be careful trading countertrend rallies in weak sectors and that just because a stock has suffered a huge decline and looks oversold, it can always go lower and even head to zero!

Now, admittedly, trading ETFs is safer than trading individual stocks but when all the components are dropping like a hot knife through butter, be very careful, there could be more damage ahead and the sector can stay out of favor for a lot longer than anyone expects. There are plenty of other coal stocks that got slaughtered this year (or filed for bankruptcy).

Have a look at the one year chart of Peabody Energy (BTU), one of the few coal companies whose shares are still trading (click on image):

OUCH! King Coal is dead! And there are plenty of others that were flying high during the BRICS' boom years which are now trading for pennies or bankrupt (like Walter Energy and Alpha Natural Resources).

When I talk about coal stocks to traders, they invariably tell me that natural gas has effectively displaced coal, but if you look at where nat gas prices are trading and charts of stocks like Cheasapeake Energy (CHK), you see the carnage has spread in that sector too (click on image):

It's no wonder so many traders are shorting every commodity. The charts are ugly and there are plenty of macro reasons to think it can get a lot uglier before it gets better.

But go back to carefully read my comments on Bridgewater turning bearish on China and a tale of two markets. We could be setting up for some nice countertrend rallies in Chinese (FXI), emerging markets (EEM), energy (XLE), commodities (GSG), metals and mining (XME), and gold (GLD) shares in the next few months.

How is this possible? First, if markets deteriorate further, the Fed won't hike rates this year. Second, real rates in emerging markets remain too high relative to real rates in the developed world, so expect more central bank easing in emerging markets in the near future. Third, the reflationistas may be temporarily right,  global growth will likely come in stronger than anticipated in the next few quarters, which will help boost energy and commodity shares.

But make no mistake, my long-term forecast of global deflation remains intact which is why even though I might be tempted to trade countertrend rallies in energy and commodities, I keep steering clear of these sectors in favor of tech (QQQ) and biotech (IBB and XBI).

The problem with tech, however, is that it's a concentrated few high flyers like Amazon (AMZN) which just reported stellar numbers that are driving the NASDAQ to record highs. I find the breadth in biotech is a lot better and can find opportunities in many large, mid and small cap biotechs.

Here are some of the smaller biotechs I trade and hold core positions in, courtesy of Broadfin, Baker Brothers, Point 72 Asset Management and other top funds I track every quarter (click on image):

But biotech isn't for the faint of heart. On Friday, shares of Biogen (BIIB) are getting slammed hard as the company slashed its 2015 forecast as MS drug sales disappoint (click on image):

Take it from a guy with progressive MS who knows Biogen very well (I was among the first Avonex patients in Canada taking part in the CHAMPS study back in 1997) and is taking part in clinical trials at the Montreal Neurological Institute. I have many conversations with my neurologist, MS patients and clinical trial coordinators and know all about new therapies. As such, I can unequivocally tell you Biogen is one of the best biotech companies in the world and they have an incredible pipeline for MS, Alzheimer's and other neurological diseases. This dip is another big buying opportunity, especially if its share price falls below $300 a share (doubt it). 

Lastly, I'm a macro and stock market junkie who tracks thousands of companies in over 100 sectors and industries. I've built that list on Yahoo Finance over many years and keep adding to it every day. I regularly look at the YTD performance of stocks, the 12-month leaders, the 52-week highs and 52-week lows. I also like to track the most shorted stocks and highest yielding stocks in various exchanges.

At night before bedtime, I sit on my iPad and go over various sectors, thinking hard of the macro themes driving the shares higher or lower. Macro is the key and those who ignore it or dismiss it are doomed to underperform.

Below, Mike Harris, president at Campbell and Co. said Thursday on CNBC's "Futures Now" that he's "short almost every commodity right now." That's a great trade for now but I wouldn't get too greedy shorting commodities, in these markets, pigs get slaughtered.

Hope you enjoyed reading my weekend comment. As always, please remember to support my efforts via your donations and subscriptions by clicking the PayPal buttons on the top right-hand side. I thank many of you that have subscribed and invite many others to join them.