It May Be Time To Question Dr. Copper's Degree

Includes: CU, JJC, SPY
by: John DiCecco

Copper is often referred to as "Dr. Copper" in the investment world and has been granted an honorary PhD in economics because of its perceived ability to forecast the strength or weakness of the global economy.

But a review of a 20-year chart comparing the price of copper to the S&P 500 (NYSEARCA:SPY) brings into question the validity of Dr. Copper's degree.

It is generally believed that a rising copper price reflects a growing global economy, and consequently higher moving equity markets; and that a falling price of copper signals a weakening global economy, and consequently falling equity markets.

We can see in the chart below that this correlation between copper prices and US equity markets really only began in 2008. From 1992 to 2007 there was no clear definitive correlation between the two.

Why is it important to understand the historical relationship between the price of copper and the S&P 500? Well, for the first time since 2008, we are starting to see a divergence between copper and the S&P 500: since the beginning of 2013, the S&P 500 has been moving higher (+8.3%), but copper has been moving lower (-5.1%).

Does the declining copper price in early 2013 portend a slowing global economy and imminent decline in the S&P 500? Or have we seen this movie before?

We have seen this movie before (negative divergence between copper and the S&P 500), but it was not a tale of decline for the S&P 500. From 1995 to 2000 the price of copper declined 42%. But over this same time period the S&P 500 climbed 340%.

It is, therefore, indeed possible for equity markets to climb higher while the price of copper is falling. It appears that copper is not as astute in economics as popular lore would lead us to believe.

A falling copper price is not necessarily a harbinger of falling equity markets.

We think that the negative divergence between the price of copper and the S&P 500 that we've seen so far this year may actually be a bullish sign for US equities. Similar to the negative divergence that began in 1995 and preceded the 340% bullish run in the S&P 500.

Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.