Copper broke out of its final frontier of price resistance last week to make new highs and the leading indices of the world, like S&P 500, Dow and NASDAQ 100, seem to be following suit.
Demand for copper is often an indication of how the global economy will do in future. In fact, prices of copper tend to rise much before the stock markets and the economy. The reason is simple. Copper is used in most manufacturing activities and a rise in demand for copper shows that economic activity is likely to pick up.
This theory was proven during the recent recession and also in June of last year. In December 2008 the prices of copper bottomed as shown by Dow Jones UBS Copper sub index and began to rally. However, the S&P 500 continued to fall till March 2009, before rallying. The copper demand clearly showed that the real sector and its producers were turning bullish and the stock market caught up later.
The same happened in June 2010. The copper index bottomed during the week ending June 11, but the S&P 500 continued to fall for three more weeks, before rallying. The influence of copper on the broad market has been proven time and again.
Now with the copper index breaking out to new highs the bulls are celebrating. The copper index had made a high of 488 in May 2008 and last week it broke out of that high after consolidating in the area for about six weeks. The fact that prices consolidated in that area for a long time shows that the supply has been absorbed by the bulls. This indicates the strength of the bull increasing the possibility of a further rally.
Note that there are no pre-existing supply areas for copper above the 488 level and the only thing that can lead to a drop in copper will be a lack of buyers. There are several reasons demand can falter but the key one would be high inflation making copper unaffordable. Also, a hike in the US interest rates could stem copper demand as could a rally in the US Dollar.
This however does not mean that we would rush in to buy copper. We would wait for the index to close above 500 which is key psychological number and then buy pullbacks.
Interestingly as copper broke out of resistance so did the S&P 500, Dow and NASDAQ 100. The resistance on the S&P 500 was 1300, 12,000 on the Dow and 2,325 on the NASDAQ 100. All the three indices were above these levels last Monday. If copper continues to rally we may see the equity markets follow as they have some room to run to the next level of supply.
The author is based in Chicago and is the editor of www.capturetrends.com
