CHARTWORKS - NOVEMBER 21, 2005
Copper - Opportunities in the Base Metal Sector

Technical observations of RossClark@shaw.ca

Bob Hoye
Institutional Advisors
Nov 23, 2005

Over the past few months, copper has enjoyed a terrific rally. Indeed, as outlined in the first chart below, the move since July has been historically remarkable. A following table places the whole bull market in perspective.

First of all, a cyclical high was likely to have been set with the general stock market in the August - September window. It seems that while this is being accomplished by the stock market, copper soared from 1.50 in July to 2.10 (Comex prices).

On market dynamics, the chart is registering the highest MACD in 45 years. Arithmetically speaking, this is no mean feat and a reversal is inevitable.

• Note the high on the RSI and the negative divergence.
• Huge short squeezes are associated with tops rather than bottoms.
• The Tin Council (think "cartel") squeezed the shorts in 1985. Tin spiked at 5.93 in June and crashed to 2.41 in July, 1986.
• This made OPEC (oil cartel) vulnerable and anticipated the crash in crude from 31.7 at the end of 1985 to 10.4 in March, 1986.

When?

In the following charts, Ross outlines a "past-due date" for copper based upon the negative divergence provided by the action in Inco stock. This connection has been reliable.

OPPORTUNITIES IN BASE METAL STOCKS
( using Inco as the proxy)

Technical observations of RossClark@shaw.ca

Over the years Inco has been the stock with one of the best correlations to copper prices. Prices have trended together well and the seasonal break from March highs through April/May has been present in both, providing both an exit and re-entry point in the stock.

The current conditions are presenting what appears to be an important clue to direction over the coming months. The following two charts display the weekly price of copper and Inco since 1991. This month's action has generated the ninth bearish divergence, as copper prices have moved to new highs unconfirmed by the price of Inco. If this divergence remains in place and copper rolls over we can anticipate a fairly significant decline in both items.

Another technique we've previously utilized for Inco appears appropriate right now. Based upon previous examples, Inco prices should test or violate the 10% band below the 55-week moving average (currently CDN$43.50).

OPPORTUNITIES IN COPPER

The recent powerful advance in copper prices can be attributed to the news of the short squeeze on the London Metals Exchange. The word around the street is that the short position for December delivery was built up into March, but was not covered into the correction during the spring. Invariably, once the massive Chinese short position in copper is covered we could very well be left with a vacuum of buyers and a corrective decline could be quite dramatic. First support is likely to occur around the 21-week average (currently $1.69). Following such a break, we would look for another rally into the seasonal high in March. Such action can produce a series of opportunities. The producers will likely get hit during a decline while the consumers will benefit. This could be similar to the action seen in the energy sector in recent months.

Just think back to August/September when the greatest fears were over the price of energy and the effects on the transportation industry, in particular airlines. Once the oil market rolled over the airlines (CAL example below) bounced back to life.

HISTORICAL PERSPECTIVE

The era of bubbles that ran until 1873 had some similarities to today's era of great asset inflations. One was the fiat dollar.

After increasing for some 20 years, commodity prices became highly speculative. That was in both price action and intellectual passions.

One of the leading economists of the day, [William] Stanley Jevons, extrapolated soaring prices and consumption into a lack of supply that was so serious that it would severely impair prosperity and would threaten the existing high standard of civilization.

His book was published in 1865 and was called The Coal Question: An Inquiry Concerning the Progress of the Nation, and the Probable Exhaustion of Our Coal-Mines.

One of the salient observations was "Coal in truth stands not beside but entirely above all other commodities. It is the material energy of the country - the universal aid - the factor in everything we do. With coal almost any feat is possible or easy; without it we are thrown back into the laborious poverty of early times."

The book also included "This is a question of almost religious importance," which view has been repeated in the "Peak Oil" passions of today.

With this, a great bubble in stocks and copper blew out in 1873 and The Economist summed it up with marvelous irony. That's both then and for conditions today.

"By articles in newspapers, reviews and magazines all sorts and conditions of men were induced to interest themselves in copper. It was shown by figures and arguments, apparently conclusive, and presented with great ability . . . that the world's [supply] of copper would be so much reduced that famine prices must prevail. The confidence in the future was strong enough to cause a further advance of 25 per cent, which was more than lost in the sequel, furnishing a fresh illustration of the rapid action of high prices in these days in bringing forward supplies from every quarter of the globe."

The subsequent contraction in highly inflated stock prices was significant.

An index of coal producers reached 50.6 in August 1873, from which the first bear market took it down to 23.1 in February, 1879.

After a rebound to 44.8 in 1881, the coal index fell to 12.7 in May, 1885. The low at the contraction trough was 12.5 in 1897.

Enjoying a bigger party, the mining and smelting index soared from 99 in January, 1871 (there was the Franco-Prussian War and the world was going to run out of copper) to 447 in late 1872. From a high of 419 in 1873, the mining index declined to 24 (no typo) in 1884. The low with the depression bottom was 25 in 1897.

CURRENT EXCESSES IN COPPER

In admitting that it is still difficult to precisely quantify effervescence, it is at least methodical to make comparisons on a deflated price basis.

The following table provides the appropriate comparisons on all of the big bull markets on a database beginning in 1913. Note that the current one has clocked the biggest gains in over a century.

Clearly, the combination of both a bubble in industrial commodity prices, a mania in intellectual speculation, and a specific short squeeze in copper has ramped copper's real price to an extraordinary level.

This represents equivalent risk to long positions, both in the metal and in the mining stocks.

Bob Hoye
Institutional Advisors
E-mail bobhoye@institutionaladvisors.com
Website: www.institutionaladvisors.com

CHARTWORKS - NOVEMBER 21, 2005

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