For folks awaiting an entry point for a directional bet in the futures, not yet.
From Verdad Advisers:
Doctor Copper
To prepare for a sea war with France, in 1807, Britain re-hulled the Royal Navy fleet with copper. This additional demand caused copper prices to more than double, sending them to the highest level of real prices on record ($27,400/ton in today’s dollars versus current price of ~$10,000/ton).
This episode marked one of the first copper booms and busts in recorded history, but it certainly was not the last. A cursory glance at copper’s price history reveals its highly cyclical nature.
Figure 1: Real Copper Prices (1850–2016)
The likely reason for copper’s cyclicality is that copper, like oil, is
linked to the economic cycle and the aggregate level of business
activity due to its widespread applications throughout the economy.
Copper is sometimes referred to as “Doctor Copper” because of its
ability to gauge the health of the economy and foretell turning points
in business activity. In good times, when businesses expand and consumer
spending is high, more copper is needed for factories, cars, or
consumer electronics, which is why copper should perform best at the
beginning of business cycles, when the economy is booming.
To test that hypothesis, we looked at three-month forward returns of
copper futures by three-month trailing changes in the high-yield spread.
A falling high-yield spread suggests the economy is expanding, while a
rising high-yield spread suggests the economy is slowing down.
Figure 2: Annualized 3M FWD Returns of Copper Futures by Quartile of HY Spread Change
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Source: Bloomberg, FRED
Historically, copper has performed best when the high-yield spread was
falling, a proxy for a growing economy, and worst when the high-yield
spread was rising, a proxy for a slowing economy. Armed with this
insight, we replicated the simple strategy that we had previously
created for oil (see On Oil)
and applied it to copper: if, over the last three months, the
high-yield spread has fallen, then our strategy goes long copper
futures. In the event of rising spreads, we tested three alternative
scenarios: the first one involves keeping the capital out of the market
entirely when not invested in copper futures (“L/Out”); the second
scenario goes long 10-year US Treasurys when not invested (“L/10Y T”);
and the third scenario adopts a shorting component based on the same
high-yield signal, which ensures that the investor is either long or
short copper futures at all times (“L/S”).
Below we compare the performance of this strategy and its various constructions with a simple buy-and-hold approach in copper.
Figure 3: Performance Indicators for HY Strategy with Different Combinations (1989–2020) |
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Source: Bloomberg, Verdad
Evidently, timing the business cycle based on the high-yield spread
dramatically improves copper performance. In the “L/Out” scenario, when
the portfolio earns 0% nearly half the time, the signal helps improve
performance by 300bps while reducing drawdowns by a third. Similar to
our results for oil, the winning strategy is to go long 10-year
Treasurys when spreads are rising, as doing so produces the highest
returns, lowest drawdowns, and highest Sharpe ratio of all four
combinations.
We can then explore how this strategy would perform within the context
of a traditional portfolio. Below, we compare the returns of a 60%
stock, 40% bond portfolio to a portfolio comprised of 60% stocks and 40%
the “L/10Y T” copper strategy.
Figure 4: Strategy in Context (1989–2020).... | |
Previously from Verdad:
And back in the before times, January 2020, FT Alphaville caught a nice idea from Verdad's founder, among others:
...One particular point, made by investors such as Verdad Advisers’ Dan Rasmussen,
is that private equity returns are fundamentally the same as those for
leveraged, mid-cap public equities. The only difference being that
volatility in a private equity portfolio, due to the owned businesses
having no day-to-day prices, is masked....
