The leading indicator of the equity markets — copper — is giving scrambled signals with a bullish breakout, but lagging the markets.
Copper usually leads the equity market, both up and down, but is now giving confused signals. First, a few words about the copper-equity market link. The relationship between copper, the equity market and the economy have been clearly established time and again.
Since copper is used in most manufacturing processes, a fall in copper prices shows a drop in demand for the metal. This, in turn, indicates that manufacturers don't need the metal as they foresee a slowdown in their business. When manufacturers slow down, so does the economy. Since the stock markets discount the future, they tend to fall a little after copper prices fall, and vice-versa, in a bullish scenario.
For instance, in December 2008, copper stopped falling and rallied. However, the equity markets began to rally only a few months later, in March 2009. Again, in February 2011, copper began falling, but S&P 500 continued to rally and fell strongly a few months later.
In our column on Decem-ber 14, 2011, we had mentioned that copper was forming a symmetrical triangle with a bearish bias. We had also mentioned that if the price of copper broke above the triangle, the bearish bias should be abandoned in favour of the bull.
Earlier this month, copper broke to the upside, giving a bullish signal, and took the equity markets up with it. It also broke another resistance level, as shown in the chart, indicating that prices would head higher. The symmetrical triangle and breakout is shown in the chart. We are looking at the continuous futures contract of copper (symbol: HG), with each contract controlling 25,000 pounds of the metal.
The breakout of resistance shows that copper is now headed to the next resistance zone between $4.12 and $4.21, and, going by the past experience, the equity markets should follow. Both the US and Indian indices were at resistance along with copper last week. It was felt that this would lead to both copper and equities falling. However, with the copper breakout, it's now likely that even equities will break out.
The bullish signal given by copper is, however, scrambled. Copper is supposed to lead the equity markets up. But a step back to the longer-term picture shows that's not the case. The Dow and Nasdaq 100 have reached the September 2011 highs from where they had fallen sharply. Copper, however, is 16 per cent below the September 2011 level of $4.50. At the time of writing this article, Tuesday morning in India, the price of copper was at $3.80.
The price action clearly shows that copper has been lagging the equity market of late, casting doubt on the break out. At this time, our bias would be neutral to cautiously bullish on copper and neutral on equities. But, if copper shows substantial strength, we would turn cautiously bullish on equities, too.
The author is based in Chicago and is the editor of www.capturetrends.com
