Tickers in this Article: SCCO, TCK, JJC, SPY, RIO
The recent pullback in copper prices has prompted plenty of discussion about the economic-predictive power of the commodity. The so-called "Dr. Copper" model suggests that copper demand, since it's a common metal used in a variety of industrial applications, is a very real-world kind of business barometer. If copper prices sink, it can only be because demand is low, which in turn can only mean the economy is slipping into a recession.

Such speculation makes sense, which is why so many pundits are pounding the table about the approximate 30% dip of iPath Dow Jones-UBS Copper Subindex Total Return ETN (NYSE:JJC) since April, the worry being that it's yet another layer of evidence that there's no hope for the market. Many of these experts even cite a "strong historic correlation" between copper prices and the broad market or a market-based ETF like the SPDR S&P 500 ETF (NYSE:SPY). Before taking their gospel at face value though, investors may want to explore that correlation a little better.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Hit and Miss
To be fair, the correlation between copper prices and the stock market since 2002 has been modestly evident. High-grade copper bottomed at $0.61 per pound in late 2001 and the market started to rebound the next year. Copper also peaked at $4.26 per pound in May of 2008 and the market went on to completely melt down later that year.

Bluntly though, the theory doesn't hold up all that well, outside of those 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.

At some point, bear markets actually coincided with a rise in copper prices. The market slump between late 1972 and late 1974, as an example, saw copper prices soar for the bulk of that time frame. Broadly speaking, the correlation hasn't been consistent enough for the last 40 years to truly call it a correlation. It's just a term dusted off and used when it works, and excused when it doesn't. (Find out how Yasuo Hamanaka's actions in the copper market forever changed the rules for commodity traders. For more, see The Copper King: An Empire Built On Manipulation.)

Seeing What We Want to See
Just for the sake of argument, investors may want to ask themselves if they've been convinced of a conclusion and are now selectively seeing the evidence to support that idea. Psychologists call it "confirmation bias;" a phenomenon where individuals subconsciously weed out information that may prove them wrong, yet seek out the data that affirms their opinion.

In this case, some of the conflicting evidence may be that Teck Resources (NYSE:TCK) just posted one of its most profitable quarters in years and, as of the last look, is expected to post record-breaking profits in 2012. The same goes for Southern Copper (NYSE:SCCO) which just posted its best quarter in years, expecting 2011 and 2012 to be earnings record-breakers.

But what about the looming lull in demand? So far it's just been an assumption from traders. Charlie Sartain, CEO of copper miner Xstrata, recently said demand for copper cathode is still out-pacing supply and he expects that to be the case through next year. Scandinavian copper producer BolidenAB's CEO, Lennart Evrell, continues to see "good demand" from Europe, a statement made just a few days ago, well after copper prices began to implode. Rio Tinto's (NYSE:RIO) U.S. Copper division CFO, Kay Priestly, recently predicted that the recent volatility isn't apt to slow down the forecasted 40% increase in copper demand between now and 2020.

In reality, the only thing that's pulled the rug out from underneath the copper market (and all markets for that matter) is speculative fears of an economic slump. There's still very little evidence of such a contraction though, despite what it may seem like when one turns on financial news TV. As they say, economists have predicted nine of the last five recessions.

The Bottom Line
The truth of the matter is, it is possible we're entering an economic contraction. It's also possible we're not entering one. To let a hit-and-miss assumption like a copper/market correlation serve as the basis for a decision, however, is a mistake, no matter which side of the fence you're on. (For related reading, see Using Base Metals As An Economic Indicator.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

comments powered by Disqus

Trading Center