Speculators in the copper market have learned recently that when fundamentals turn against risk assets, access to supposedly cheap liquidity can keep things going for a while before the truth catches up and prices collapse.
It’s just like Wile E. Coyote running off the edge of a cliff, Albert Edwards notes in his latest Global Strategy Weekly for Dresdner Kleinwort (full report, DK clients only). Too often we hear the spurious argument that liquidity is a key reason for buoyant markets, but ample liquidity is caused by good price momentum rather than the other way around.
Liquidity is the caravan not the car, and if they both go too fast it will all become horribly unstable, Edwards says.
The Dresdner man’s thesis is that simply saying cheap money is keeping asset prices high is tantamount to explaining the inexplicable by voodoo. Despite supposedly ample liquidity the copper market, price has dropped 20 per cent over the past month — a response to rising inventories which, in turn, have grown as the global economy has slowed. “And if copper, why not other risk assets? Using liquidity the way a voodoo priest might use chicken entrails can seriously damage your wealth.”
“We think many commentators often have their causality the wrong way round. It is price momentum that causes people to borrow and speculate on further price movement. Liquidity can accentuate a market movement that is already underway. But as copper investors will testify, if the fundamentals are sufficiently undermining, liquidity arguments are not worth the paper they are written on. Poof! Liquidity can evaporate overnight.”