The Significance of Copper's Current Price Moves

As if the plunging prices of oil weren't enough to worry about, pundits are now citing a "crash" in copper prices as further confirmation that the health of the global economy is deteriorating rapidly.  I've heard some question whether copper is signalling a global recession, or if it's signalling significant weakness in the US and China at the very least.  Well, before we start forecasting impending doom, let's take a step back and look at this "crash" from a broader perspective.  Here's the weekly chart of copper prices from 1/3/2000 to the present.

$COPPER EOD Price

As you can see from the chart, Copper has a tendency to follow global economic health.  Whether or not we can call it a leading indicator is somewhat doubtful, though, and in my view it would be a stretch of the imagination.  The two shaded green areas on that chart show the extreme market crashes that followed the September 11 attacks in 2001 and the financial crisis in 2008. 

Nobody will argue that any market indicator could have foreseen the market crash following a major terrorist attack, so there were no leading indicators that would have foreshadowed the post 9/11 crash.  Yet, as you can see from this chart, Copper started heading down following a peak over a year earlier.  Conclusion: there was no correlation between the two.

Look at the 2008 scenerio.  Again, Copper was trading in a very gradual incline until the financial crisis hit, and it then followed global markets down, just like every other commodity.  The key is, it followed, but it didn't lead.  Benefiting from a plunging dollar and a surge in economic growth in China, Copper surged from mid-2008 until the Commodity Bubble burst in 2011. 

The 2011 burst of that bubble was inevitable, since it was not possible for China to continue the level of growth it had sustained for the prior three years.  As China slowed, so did the demand for copper, and the prices gradually declined.  You can see from the chart, in fact, that the price managed to find some support around the 61.8% Fibonacci Retracement line, until it finally penetrated that line for good in November, 2014.

In the past two months, we've seen a significant drop in price back to the 50% Fibonacci line, but before we panic, let's stop and thing about what drives the price of copper.  There are three factors:

1.  Demand, primarily in China.  Well, that demand appears to be holding steady.  It's not growing, but neither is it dropping at any significant rate.  In fact, some of the early guidance we're hearing out of companies with exposure to China seem to indicate modest growth there for 2015, so I don't think weakening demand is driving the price down.

2.  Supply.  Well, it's definitely possible that there's an increase in supply.  There was speculation last week coming out of Morgan Stanley's commodities analysts that a drop in oil prices would encourage mining companies to increase their production of commodities such as copper.  It's possible, but I doubt that's what we're seeing in the current price drop.

3.  Strength of the US Dollar.  Here, folks, we have the winner.  The price of commodities, including copper, carries an inverse relationship to the value of the dollar.  As the dollar increases, commodities prices fall. What we've had in the last few months is a very sharp increase in the value of the US Dollar, culminating with Friday's 10-year high against the Euro.  This factor alone fully accounts for the sharp drop in copper prices last week.

Is the global economy weakening?  I'd certainly say Europe's is weakening, but China appears to be holding steady, as is the economy in the US.  Growth is weaker than I'd like it to be, but there's nothing out there indicating an imminent recession.  So when we look at the plunging prices of commodities in general and copper in particular, let's not forget that it's more than a supply and demand equation.  Factor in the value of the dollar and we have a perfectly good explanation for the behavior without resorting to a doom and gloom economic forecast.