March 28, 2013 at 02:46 AM EDT
What Investment Strategy Works with Weak Economic Growth?

Investment Strategy Works with Weak Economic GrowthOne of the most difficult things to do is to try and determine the future level of economic growth. There are so many variables that go into the level of economic growth that no model can accurately predict the exact level.

What we can do is look for signs of economic growth, or a lack thereof, and create an investment strategy based on these indications. Looking backward won’t help; we need to look forward.

One method that can help is to see what the professional investors are doing, as they are on the cutting edge when it comes to creating a profitable investment strategy.

Last week saw two distinctly different moves by professional traders. The first was that hedge funds made a massive trade against copper. With global inventories piling up, professionals have an investment strategy that will benefit from the price of copper if it drops.

Clearly, the professional traders don’t believe there will be enough economic growth to absorb such a high level of inventory, which is currently at a nine-year high globally. (Source: Richter, J., “Hedge Funds Most Bearish Ever on Copper, Favor Gold: Commodities,” Bloomberg, March 25, 2013.)

Hedge funds increased their short positions in copper by a massive 53% last week, according to the Commodity Futures Trading Commission. Copper is closely associated with economic growth, since so many industries use copper. As economic growth expands, the use of copper does as well.

The build-up in copper supply is worrisome, as this means that either builders are holding back on ordering more copper, unsure of how strong economic growth will be in the second half, or that analysts are too optimistic in general regarding global economic growth potential.

The level of copper inventory increased by 77% so far in 2013—the highest since 2003, according to the London Metal Exchange. While we are all aware of slow economic growth in Europe, many analysts had hoped that both China and the U.S. would rebound strongly. With hedge funds creating an investment strategy to profit from a drop in copper prices, clearly, they don’t believe there will be substantial growth anytime soon.

Conversely, hedge funds have piled into gold, with professional traders utilizing the short-term investment strategy of the yellow metal as a possible profitable trade from the instability in Europe. Professionals increased their bullish bets by 63% last week, the largest increase since the fall of 2008.

This also is a worrisome sign for global economic growth. If economic growth really was close, we would see hedge funds moving out of gold as an investment strategy, since that would signal that the need for central banks to print money is closer to an end.

While a large part of the move into gold by hedge funds was an investment strategy based on the Cyprus situation, if economic growth really was accelerating, the crisis would not be as severe. A lack of economic growth exposes the structural imbalances in an economy.

Uncertainty is a huge issue when trying to create a long-term investment strategy. In the U.S., the constant political battles are creating an unhealthy environment for businesses to expand and create jobs. Economic growth can be curtailed simply from a lack of confidence in our political leaders.

While there are some positive signs in the U.S. that economic growth is improving, I would urge some caution, as we would need to see several more months of improving strength in addition to some sense of normalcy return to the rest of the world.

At this point, there appear to be more hurdles for global economic growth for the remainder of 2013. I would be taking profits in stocks that have run up a lot and have unrealistically positive assumptions for earnings growth. I would also consider buying stocks that will benefit from lower copper prices and possibly short stocks that need higher copper prices to increase their corporate earnings.

The post What Investment Strategy Works with Weak Economic Growth? appeared first on Investment Contrarians.

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