Sent: 26-05-2009 09:55:03
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Metal Price Winners and Losers
Analysts are fooling themselves if they think they can consistently pick whether one metal price is going to fare better than another.
I came across a weighty report from a major international broking firm in the past week which identified zinc as the metal with the strongest price upside potential. Naturally enough, for a broker, there was an accompanying selection of zinc producing companies from around the world in which to invest.
Similar reports are so commonplace that they can easily mislead readers about the worth of such research.
As we have discussed in these emails before, there is academic research which shows that returns from investing in commodity producing companies are more closely correlated with their home equity market returns than with movements in the underlying commodity prices.
This suggests that getting the commodity price forecast right, in any event, is not a sufficient condition for a positive investment outcome.
Secondly, the correlation between movements in different metal prices is sufficiently high that disparities in performance occur less often than analysts pretend.
Prices data for aluminium, copper, nickel, lead and zinc give us some sense of the limited opportunities to pick and choose. For the purposes of the following analysis, I have used monthly average prices between 1980 and 2008 to give us 348 data points.
The correlation coefficients of the time series are as low as 0.71 for aluminium and lead and as high as 0.89 between zinc and nickel.
The correlation in monthly returns is, understandably, lower. Again, the lowest correlation of 0.34 is between aluminium and lead. The highest correlation of 0.50 occurred between copper and aluminium as well as between copper and zinc.
The correlation in rolling three monthly returns is a little different. The lowest correlation (0.29) is between lead and nickel. The highest correlation of 0.56 is between aluminium and nickel.
An analysis of the direction of change shows the connection between price movements more clearly. Prices of most of the metals moved in the same direction most of the time.
An analysis of three month rolling returns, for example, shows that prices of at least four of the five metals moved in the same direction 65.8% of the time.
Prices of three or more of the five designated metals moved in the same direction over any three month period 100% of the time. You cannot get much higher than that.
Analysts are paid for their finely honed and detailed knowledge of these markets. Their history shows, however, at least over the timeframe reviewed here, that a standout difference in performance is going to be rare no matter how dogmatic an analyst might appear to be about its possibility and no matter how weighty the publication accompanying the recommendation.
Committing the time and effort to work out whether zinc prices are going to outperform copper prices (or any other combination) might simply be a waste of resources that risks leading investors down an analytical cul-de-sac.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.