Dr. Copper Screams, 'Danger Ahead!'

Includes: JJC, JJCC
by: Wall Street Sector Selector

By John Nyaradi

Dr. Copper, a leading economic indicator, doesn’t like what he sees ahead.

Copper (NYSEARCA:JJC) has always been seen as a useful barometer of economic health. Increased manufacturing brings an increased demand for copper. As a result, people began referring to copper as “Dr. Copper,” since it provided a good reading on the health of the economy. Demand for the metal is widespread because it is used in everything from electronics, home building and automobile manufacturing to the distribution of electricity from power stations.

Because rising prices for “red gold” signal rising economic and manufacturing demand, its price is understood as a forward-looking indicator of economic health. Hence, “Dr. Copper” can provide a prognosis as well as a diagnosis of the health of the economy.

We saw this demonstrated on Monday, September 2, after the Manufacturing Purchase Managers Indices for the Eurozone, Britain, Japan and China soared beyond expectations. The news brought a surge in the spot price of copper to $3.27 per pound from $3.20 per pound.

Despite the September 2 rise in the spot price of copper, we can see that it is still relatively cheap – signaling comparatively low demand. When the chart for the copper spot price is overlaid against the chart for the S&P 500, (NYSEARCA:SPY) we see an uncanny correlation. During the first quarter of 2012, we saw some weakness in copper and hence, the manufacturing sector, as well.

Chart courtesy of StockCharts.com.

For the month of February 2013, we see the price of copper rampantly diverging from the S&P 500 performance. In fact, the price of copper was suddenly moving opposite to the performance of the S&P. By early May, copper was again coordinated with the S&P in its rise and fall, although the gap between the two remained extremely divergent from the comparative overlay we had been seeing until February of 2013.

According to the International Copper Study Group, China is the leading global consumer of copper, accounting for approximately 40 percent of world demand for the metal. The ICSG noted that during the first five months of 2013, China reduced its imports of refined copper by 37 percent. Excluding China, year-over-year world usage of copper fell by 1.5 percent as of May 2013. The ICSG explained that world usage is estimated to have declined by around 6 percent year-over-year in Africa, 2.5 percent in Asia, 2 percent in Europe, and 3 percent in Oceania, while remaining unchanged in the Americas. After seven months of surplus, by May the copper market balance showed a relatively small, 17,000 metric ton deficit. This would explain why the spot price for copper was again rising and falling in coordination with the S&P 500 in May.

Despite the September 2 rise in copper’s spot price to $3.27 per pound, it would have to be selling at approximately $4 per pound, before it would be accurately aligned with the S&P 500, as it was before China reduced its demand for the metal in February.

Bottom line: If China’s manufacturing sector continues to rebound, we may soon see copper prices re-aligned with the S&P 500. On a technical level, either Copper (JJC) has to rise or the S&P 500 (SPY) has to fall to repair today’s dangerous divergence. Copper would have to reach $4.00/lb on the upside, while the S&P 500 would have to fall to approximately 1200, a decline of approximately 25% to repair today’s dangerous divergence.

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