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Dr Copper, China and the Stock Market

Copper prices are year to date down by over 10% with only silver and platinum recording lower figures amongst the metals. This has caused many to point out that there is a huge disconnect between the stock prices that are trading higher and the economic activity in the world. Copper is a metal that is such an integral part of many manufacturing processes that it is often quoted as Dr Copper, a metal with a degree in finance. Analysts and financial journalists often claim that the price movements in copper have predictive value for growth expectations in the world economy and therefore for the stock market as well.

However, looking at the history, the track record for Dr Copper’s ability to predict the stock market’s movements is somewhat patchy. Copper declined during the period of the rising stock market (S&P 500) prices in 1989 to 1993 and again after a period of rallying copper prices, the price of the red metal declined between 1995 – 1999.

Copper W1

If you recall, the stock market was at the time experiencing one of the most bullish periods in its history. Then again we had a brief period of bullishness between the beginning of 1999 and the latter half of the year 2000. So, “the doctor” advised to go long in stocks almost at the tech bubble high. Then the two came down hill hand-in-hand until late 2002 when copper started to move higher while the equities still continued southward.

Copper W2

Since then we have seen a greater degree of success in the doctor’s prediction business as the price of copper started to stall during the first half of 2006 and did not make a new high before the US subprime bubble caused the stock market to collapse. However, this success was not going to last. Since the beginning of 2011 copper prices have been trending lower while the S&P 500 has been rocketing higher. Someone investing based on Dr Copper’s advice would have suffered extended periods of non-performance or huge drawdowns.

What then should we think about the latest disconnect between the price of copper and stock markets in general. It is clear that stock markets have risen on the basis of central banks devaluing their currencies via quantitative easing programs, meaning that the rising trend in asset prices has less to do with real economic activity than the activity from central banks. It is true that the valuations for stocks were too low in 2009 and the current rally is partly due to a reversion to a mean reaction (market correcting those extremely low valuations) but at the same time we have had extraordinary money printing from central banks with quite a minor impact on economic growth and inflation figures. This is partly the reason for lacklustre performance of copper prices. If we were experiencing a meaningful and healthy global recovery it would mean more demand for copper and would be reflected in the price of the red metal.

Since the early 2000s we have had a new and pretty sizeable player in the physical copper market. China has been consuming vast amounts of copper and accounts today around 40% of global consumption of the metal. If China is a vast consumer of this metal with an increasing appetite, then the math should be pretty simple and conclusions straightforward: buy more copper. However, as we can see from the copper charts, the price of copper has been coming lower for the last four years.

China has not been a simple story for analysts to decipher. Even though China had a period of decreased economic activity, the country’s copper imports did not decrease but increased. It turned out that because Chinese banks had aggressively increased their lending during 2009 – 2010 period, while boosting the infrastructure and property projects, they became worried about defaults on these loans. This led to banks asking for physical deposits for loans, which in turn led to Chinese borrowers hoarding copper. Borrowers imported copper to China but kept it in warehouses (in harbours in order to avoid import duties) as collateral for short term loans. Now that the government has cracked down on these types of financing deals, vast quantities of copper have been released to the market. This has obviously put pressure on copper prices. Now based on this, one could argue that this supply has cloaked some of the impact of real demand for the metal and therefore we should be optimistic and bullish on the price of copper over the medium term.

However, it is challenging to really be confident on knowing what is going to take place. China being as complex as it is and the world economy attempting to recover with a life support from the central banks, it is very difficult to make credible predictions on the price of copper based on the fundamentals. We are once again faced with the fact that the price action in copper is the most reliable and efficient way of estimating future price moves.

Copper W3

Copper, weekly: The price of copper has been in a range between the weekly lows from August and the weekly pivot low from March this year. Overall the market is still in decline with lower lows and lower highs clearly visible on the chart. The nearest weekly resistance is at the latest highs at $3.11 and support at $2.95. We might see a rally above the regression channel but look for shorting signals at around the resistance area.

Copper D1

Copper, daily: Copper is bouncing higher from a weekly support and looks like it will attempt to challenge the resistance at around the daily Bollinger Bands. The August reaction lows are defining a very potential resistance area between $3.08 and $3.12 that coincides with the Bollinger Bands. Should the price be able to push through, the next level to pay attention to are the daily highs from September at $3.21. Look for intraday (15 and 60 min.) shooting stars to indicate that the momentum reversal is taking place. As we have a support below and market trading in a range, I would look to take profits as price approaches the $3.00 level.

A range bound market with a huge weekly trend lower, but also close to a support and this causes the market to be range bound. Due to the range bound nature of this market I am looking to sell the highs (resistance areas) when lower time-frame charts confirm the momentum change (from up to down) and buy the support areas when we have the opposite momentum reversal in the lower time-frames.

Disclaimer: Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of purchase or sale of any financial instrument.

Janne Muta
Chief Market Analyst

Thursday, 13 Nov, 2014 / 1:29

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