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Is 'Dr Copper' dying? - Views on News from Equitymaster
 
 
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  • Dec 20, 2011

    Is 'Dr Copper' dying?

    Traders and investors constantly search for leading indicators in the market to gain an edge in money management. The performance of base metals is an excellent way to gauge economic activity around the world. Various base metals like aluminium, steel and copper have been used by investors to gauge economic activity. But are they still reliable? We take the example of famous Dr Copper to find out.

    Who is 'Dr Copper'?

    Many traders have affectionately referred to copper as 'Doctor Copper' and it is the only metal having a PhD in economics. The metal is called doctor copper because of its widespread applications in most sectors of the economy from homes, factories, and electronics to power generation and transmission. Copper's prevalent use in industry and business makes it a good early indicator of economic growth. Generally, rising copper prices suggest strong copper demand and hence a growing global economy, while declining copper prices may indicate sluggish demand and an imminent economic slowdown.

    Is it accurate anymore?

    The correlation between copper prices and the stock market since 2002 has been modestly evident. High-grade copper prices bottomed in late 2001 and the market started to rebound the next year. Copper also peaked in May of 2008 and the market went on to completely melt down later that year. After being beaten down in the early stages of the financial crisis during 2008, copper started to pick up at the end of 2008, a considerable time before the stock markets started to show signs of life and before the global economy turned corner.

    But the theory doesn't hold up that well, outside of the above mentioned instances. Take, for instance, the bulk of the 1990s: On three separate occasions between 1990 and 1999 the price of copper slumped more than 30%, yet we didn't see a single recession or bear market start during that period. In a similar vein, copper prices tumbled more than 30% between mid-2006 and early 2007 with no bear market or recession then either. One could argue that price pullback was a very early omen of the recession that would start later that year but considering copper fully recovered and moved to new all-time highs between January of 2007 and mid-2008 (well after the recession and bear market started), it's hard to say there's any helpful predictive power evident there.

    Investors who use the copper price as a leading indicator for the current business cycle downturn are likely to be disappointed as copper is likely to lag other leading indicators. The reason for this is simple: the physical copper market is tight and has tightened further over recent months. China is the largest consumer of copper in the world today. It consumes over 40% of world's copper output currently and any slowdown there will bode ill for copper prices. Thus the prices of copper are more dependent on Chinese demand rather than demand from rest of the world thus making copper prices more volatile and difficult to read. In fact demand from emerging markets, and China in particular, has pushed the price up by more than 450% since 2001.

    Overall Dr Copper still does a fairly good job of being the economic bellwether, but its accuracy in predicting the true state of the global economy may just be little dented in this fast changing environment. It is important to remember that tracking copper to win in the equity markets is not the secret formula for success and it may not work in future.

     

     

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