Yesterday, the copper market gave a whispered that the first leg of the “infrastructure trade” may be coming to an end, at least for the time being. The chart below shows that the price of copper took off after the election. The consensus view was that the rally in building related raw materials was the direct result of the new administration’s emphasis on infrastructure developments and all the construction activities that go along with it. This thesis is supported by articles like this one posted on Business Insider.
We believe that this first leg discounted the potential for a multi-year, $1 trillion dollar spending program the federal government plans to undertake to improve the roads, bridges, rail road lines, airports, telecommunications infrastructure, etc. Some of this development in certain sectors like telecom and railroads, for example, will be carried out and financed by the private sector. We suspect there will be subsidies (either directly or through the tax code) to push this process along. Other areas that are the responsibility of either local or federal government, such as roads, bridges, and airports, will be financed by the government at some level.
But it is important to realize that the equity and industrial commodities markets have risen on the promise of acti0n. If the rally in industrial commodities and infrastructure related stocks is to continue, the government must take action. Before the President can take action, the Congress must pass legislation to authorize action and craft a budget to pay for it.
We think the drop in copper prices could be a signal that investors realize that it takes time for the government to craft legislation. We would not be surprised if it took a year or so before the first shovel broke ground, and we suspect that the market is starting to discount this possibility. The good news is that this pullback will give investors who missed out on the first run to take a position on what we think will be a more long lasting rally. In the mean time, if you want to trade a selloff in copper, we suggest you look at selling a call spread or buying a put spread on iPath Copper ETF (JJC). Since we have just witnessed a break in trend and not necessarily the start of a new trend, we are partial to selling a call spread. With JJC trading at $30.48, we would consider the following structure.
| Type | Number | Exp. Date | Strike | Net |
| Call | 1 | 4/21/17 | $35.00 | $0.15 |
| Call | -1 | 4/21/17 | $31.00 | -$1.25 |
| -$1.10 |
The investor will collect $110 up front per call spread which they get to keep so long as the price stays below $31.00 at expiration. The trade will break even at $32.10, and the most one can lose is $290. The probability of making a buck on this trade is 71%. There is one issue to be aware of here, and that is liquidity. Options on JJC are not very active and open interest is less than 1000 contracts across all expirations. So if you place this trade or one of your own design, be sure to place a limit order and be patient.
