There can be little doubt that the global economy is slowing down. As a result it is not surprising to see the price of copper declining. What is puzzling however, is the continued rally in US equities. The question is, which is right about the direction of the economy: Copper or the S&P 500?
The chart below shows the relationship between copper and the S&P 500 over the past 5 years. For the most part the movements of the two are highly correlated, however every now and then they diverge – something which is highlighted by the dip in the correlation from positive to negative (circled).
A 5 year (daily) chart of Copper & the S&P 500 Index (Click on the chart for a larger version)
Chart courtesy of stockcharts.com
Recessionary conditions in the Eurozone continue to worsen, Japan and Britain are barely registering growth, and worrying numbers continue to point to a summer swoon in the US. In addition, China’s manufacturing sector slowed unexpectedly in April, underlining concerns that its economic recovery remains fragile. Given this backdrop it’s not surprising to see that for the past three months the price of copper has been declining.
Copper is used in building construction, power generation and transmission, electronic product manufacturing, and the production of industrial machinery. It is also an essential component in the motors, wiring, radiators, connectors, brakes, and bearings used in cars and trucks, with the average car containing between 20 and 45 kilograms of the metal.
Because of this array of uses the price of copper is considered a good gauge of the health of the global economy, and right now this vital industrial metal is forecasting a global economic slowdown, or perhaps something worse. At the same time however, the value of the top 500 US companies continues to trend higher. So which one is right about the direction of the economy: Copper or the S&P 500?
The answer is neither of them.
As noted previously, since 2007 the S&P 500 has shown a high (86%) correlation with the size of the Fed’s balance sheet, therefore US equities are not solely being driven by economic fundamentals. They are being driven by the unprecedented liquidity which is being provided by the Fed and other central banks. Equity markets are also responding to the fact that:
- Central banks have driven interest rates to record lows in a bid to encourage investors to seek higher returns in other risk assets – primarily equities.
- Margin debt is at record levels.
- Corporate earnings have improved as a result of dramatic cost cutting and efficiency gains.
But, while the performance of the S&P can largely be explained by the actions of the Fed and other central banks, the price of copper is still subject to the laws of supply and demand.
What most analysts have missed, however is that the supply of copper has recently begun to increase. In fact, copper production is rising at the fastest rate in a decade, as major investment by mining companies begins to bear fruit.
A recent article in the FT notes that “Copper output in Chile, which accounts for a third of global supply, has been rising strongly in recent months, boosted by the expansion of Escondida, the world’s largest copper mine. Wood Mackenzie, a leading consultancy, expects 2013 to see the biggest percentage increase in global mine production since 2004.”
The surge in production helps explain why copper broke major chart support so decisively, and it means that so-called “Dr Copper” no longer provides us with a useful assessment of global economic health.
The bottom line
The bottom line is that right now neither the price of copper nor the S&P 500 serves as a good economic indicator, and therefore the historical relationship between the two has come to an end. At least for now.