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Copper decline could be signaling that a stock market drop is near

Copper versus stocks 04.01.2013Enlarge GraphAfter a close directional relationship for the better part of two years, the level of U.S. stocks, as measured by the S&P 500, and the price of global industrial metal copper, has diverged for over six weeks, which could mean a correction in stocks is near.

There is no better proxy for global output than the price of copper 1 which is used in more industrial functions than any other substance. The metal is an excellent conductor of heat and electricity which makes it invaluable for construction and also for use in electrical goods. It is used in the form of cables, wiring, plumbing, heating and ventilation, and in both housing and automobile manufacturing. Copper is also used exclusively in the wiring and circuit boards of phones, computers, and other electric goods. Simply put, copper is the most industrially used global metal.

Examining the price relationship of this industrial giant with the price of U.S. stocks, as measured by the S&P 500, shows a concerning break down of a pricing relationship that has held consistent for some time. Both copper and the S&P 500 fluctuated in unison for the better part of two years up until mid-February, which may be reflecting that the copper market is relaying early global slack in output which has not been picked up by U.S. stocks yet. Both U.S. stocks and copper appreciated quickly from September 2010 through September 2011 as stronger global output created stronger corporate profitability. Then both stocks and copper prices dropped dramatically for four months due to fears of a double dip recession into 2012 before rallying in unison through May of last year. Both the industrial metal and U.S. stocks again reflected similar pricing with a sharp rise into September 2012 before the U.S. election; prices declined into November due to fear of the U.S fiscal cliff before the substantial decoupling from February 2013 onward. U.S. stocks, as measured by the S&P 500, have continued to trend steadily higher with a 3% gain since mid-February through the first days of April. Copper conversely has taken a sharp step back with a 7% decline over the same time period. This price relationship is significant because it is the first major divergence over the past 30 months between these two variables.

While corporate profitability and fourth quarter earnings reports have been steady in February, and weekly jobless claims have continued to trend down which has driven stocks higher (see our analysis on the importance of jobless claims this cycle), it is concerning that future demand for broad-based industrial materials has not followed the trajectory of stocks to fundamentally support the move higher. The circumstances of a fledgling Chinese economy, an ongoing European recession, and marginal growth in the U.S., may now be filtering into the fundamental’s of the copper market which would highlight weak fundamentals. While divergence can result in either variable re-correcting to keep pace (stocks can come down or copper prices could perk up), it would seem that after a 10% increase in the price of stocks in the most recent quarter, and new potential fundamental weakness in industrial production as relayed by copper, that stocks would be the variable due for a haircut.

If stocks do reconnect with the recent fall in the price of copper, leading stock exchange traded funds would fall as well including the iShares Russell 3000 Stock Index exchange traded fund (IWV), the SPDR S&P 500 ETF (SPY), the Vanguard Total Stock Market exchange traded fund (VTI), and the iShares Core S&P 500 exchange traded fund (IVV).

  1. The price of copper in our research represents the price in U.S. dollars per ton on the London Metals Exchange.

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