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Inside the Market Gauging what’s ahead for strong run in commodity prices, mining stocks

Commodity prices and mining stocks are performing far better than global economic activity indicates they should – a situation that can’t last for long. The industry trends encapsulate a far broader investor dilemma where asset prices are climbing despite slowing global growth and weakening corporate profits.

The accompanying chart is one of my favourites and I run it every month. The purple line represents the S&P GSCI Industrial Metals Index. The blue line is the JPMorgan Global Manufacturing Purchasing Managers Index (PMI), a benchmark that compiles surveys of manufacturing executives across the world on business activity, hiring and new orders for goods. The latest PMI reading was released on Feb. 1.

It makes sense that metals prices should track global manufacturing activity – more manufacturing means more demand for the materials to make goods – and indeed the two lines on the chart move closely together for the majority of the time period depicted.

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In January, however, the global economy continued deteriorating, thanks to weak data from Europe and Asia, while commodity prices ticked higher.

Past performance suggests that the recent divergence on the chart will close, and this can happen in two ways. Either economic data improve or metal prices correct lower. In attempting to predict which scenario is more likely, it’s important to remember that the PMI survey is backward-looking while commodity prices often represent a bet on future demand levels, at least in part.

RECENT DIVERGENCE, EMERGING TENSION

S&P GSCI Industrial Metals

Index YoY % change

50%

8%

JPM Global Manufacturing

PMI index YoY % change

40

6

30

4

20

2

10

0

0

-2

-10

-4

-20

-6

-30

-40

-8

2014

2015

2016

2017

2018

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: scott barlow; bloomberg

RECENT DIVERGENCE, EMERGING TENSION

S&P GSCI Industrial Metals

Index YoY % change

JPM Global Manufacturing

PMI index YoY % change

50%

8%

40

6

30

4

20

2

10

0

0

-2

-10

-4

-20

-6

-30

-40

-8

2014

2015

2016

2017

2018

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: scott barlow; bloomberg

RECENT DIVERGENCE, EMERGING TENSION

S&P GSCI Industrial Metals

Index YoY % change

JPM Global Manufacturing

PMI index YoY % change

50%

8%

40

6

30

4

20

2

10

0

0

-2

-10

-4

-20

-6

-30

-40

-8

2014

2015

2016

2017

2018

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: scott barlow; bloomberg

Analysts’ forward-looking commentary on metals prices has been positive of late. Citigroup’s Maximilian Layton, for example, is predicting a 10-per-cent rally in copper prices as demand from China firms at a time of low global inventories. Nickel prices have already jumped more than 20 per cent from January lows, thanks to expected demand for batteries as electric vehicle sales rise.

The economic data are also improving. The global version of Citi’s Economic Surprise Index, which measures economic reports relative to consensus forecasts, has been moving higher. At minus 14.4 it’s still in negative territory, which indicates that the more relevant data are still being reported below expectations. But this is a major improvement from the minus-26 reading on Jan. 11.

Recent evidence makes an economic recovery a more likely scenario than a sharp drop in metals prices, although that could change. Further weakness in global growth data would make it difficult for metals prices and mining stocks to hold recent gains.

The chart represents a tension between bullish sentiment (metals prices) and fundamentals that is also apparent in equity markets. The S&P 500 has rallied more than 9 per cent in 2019 despite a continuing fourth-quarter earnings season that has seen full-year profit guidance drop dramatically. According to CNBC, analysts are now expecting a year-over-year decline of 0.8 per cent in S&P 500 earnings for the first quarter of 2019. In September, the same analysts predicted profit growth of 6.7 per cent for the first quarter.

For commodities and equities, December was awful and 2019 has shown a strong recovery. Investors are now looking for signs of sustainable new trends, and global economic growth and corporate earnings are likely to drive short-term results.

Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.

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