Feature Stories | Feb 07 2007
By Chris Shaw
Back in December Barclays Capital noted while higher commodity prices in 2006 had benefited mining shares there had been significant underperformance in mining stocks compared to the physical copper price over the course of the year. On its calculations at the time, while physical copper had risen more than 50% in 2006 the FTSE All Share Mining sector had rallied only 20%.
This led the broker to conduct an analysis to determine what factors would likely lead to share prices outperforming the metal price and vice versa, and whether there was a way to trade this relative performance successfully.
The group notes in terms of relative performance mining equities tend to lead returns on both share indices and the physical metal price, most likely as equity valuations respond faster to changes in the global business cycle than does the metal price itself.
It concentrated its analysis on the copper price and examined data stretching back 20 years, finding over that time frame equities tended to have a lead time in performance terms of about four months, though using data from 2003 to now the lead time shrinks to around two months.
It then assessed what factors move both the physical copper price and mining equities, determining the most influential indicator was business sentiment, particularly with respect to the gap between new orders for copper and existing inventories of the metal.
Applying these factors to historical data it found the gap provided a reasonably accurate leading indicator of copper prices of about three months, with periods where the market sentiment with respect to the gap between new orders and inventories is improving resulting in the copper price tending to outperform mining stocks and the opposite occurring when copper inventories are rising.
Applying such a model to historical data showed rather than investing in just the physical metal or in mining stocks, trading the relative movement of mining equities against the copper price produced the best returns over a 10-year period. This supported its theory there are larger profits to be made by taking advantage of relative price movements.
Based on its reading of the data in December the group suggested mining stocks were set to outperform in the early stages of this year, a view that proved to be correct given the gains from such a position were in excess of 20% since the model was constructed.
Looking at the situation based on the current data for both the physical market and sentiment indicators Barclays sees no reason to change the trade, as global business sentiment continues to decline and stocks have increased.
While it notes there is a chance the copper price will recover somewhat in coming weeks given recent copper price weakness appears something of an overreaction given stocks are still low by historical levels, such an outcome should translate into higher earnings for mining companies, so supporting their continued outperformance relative to the metal price.