What Is "Dr. Copper" Telling Us About the Stock Market?
For traders who are looking for insight into coming stock market moves, it is very helpful to look at "leading indicators" or economic indicators that have a tendency to lead stock market moves. In the world of economics, copper has been nicknamed "Dr. Copper" or "the metal with a Ph.D in Economics" thanks to its high economic sensitivity, which is a result of its extensive use in automobile manufacturing, construction (used in wiring and plumbing), metallurgy and electronics.
One of the more effective ways to use copper's leading indicator qualities is to analyze divergences between copper prices and stock prices. Ideally, stock market strength should be confirmed by rising copper prices, and vice versa, but there are times when copper prices don't confirm stock prices, and this is what is known as a divergence. Stock market tops are often preceded by weakness or peaks in copper prices, and stock market bottoms are often preceded by bottoming and strengthening copper prices.
The chart below shows the stock market bottom in early 2003, after a three year bear market that ensued after the late-1990s Dot-com bubble popped as well as the September 11th, 2001 terrorist attacks and invasion of Afghanistan. Copper prices bottomed in late-2001, and began to rise even as stocks continued to fall until early 2003. One of the reasons why copper prices started to rise in advance of stocks is because copper prices are very sensitive to interest rates, which were cut to multi-decade lows by the Federal Reserve to cushion the blow of the September 11th terrorists attacks and the post-Dot-com bubble recession. Another major reason why copper prices started to rise ahead of stock prices is because copper demand was quietly increasing as the 2003-2007 housing boom and bubble got underway, which temporarily boosted economic growth until it led to a crisis of its own starting in 2007. China's infrastructure-driven economic boom that started in the early-2000s also caused copper prices to rise and helped to boost global economic growth. The stock market bottom in early 2003 marked the start of a powerful bull market that finally culminated in late-2007, and astute copper watchers were given advance notice of this bull market.
The next chart shows the stock market peak that occurred in late-2007, after the four-year bull market that started in early-2003, as we showed in the prior chart. As in 2003, copper prices flashed an advance warning when they topped-out in 2006, even as stock prices continued to rise throughout 2007, creating a divergence between stock and copper prices. Copper prices began to stall in 2006 after a series of interest rate hikes by the Federal Reserve, and the nascent popping of the housing bubble. When the stock market crashed in 2008, Dr. Copper simply said "I told you so!"
In early 2009, after successfully calling the stock market bottom in 2003 and the start of the bear market in 2007, copper prices bottomed two months ahead of stock prices and began to rise even as stocks continued to hit new lows in March 2009. If you recall, early 2009 was the absolute apex of the Global Financial Crisis, and panic ruled the day. Despite this, copper bravely began to rise as if it knew something that the stock market didn't. Sure enough, copper accurately forecasted the four-year and counting bull market that began during the scariest financial crisis since the Great Depression.
The next chart shows current copper and stock prices, and the growing divergence between these two markets. While stock prices have risen strongly since Fall 2012, copper prices are not confirming the stock market's optimism. We saw a similar pattern during the last market peak, from 2006 to 2007, copper prices peaked even as stocks continued to rise, foreshadowing the stock market's top and ensuing bear market. The current copper-stocks divergence is something that needs to be watched very closely given its historic accuracy. While the current divergence may indicate a bearish move ahead for stocks, we must note that a divergence like this can also resolved in a bullish manner, if copper prices were to rise to match the rise in stock prices, thus closing the gap between the two markets.
In this final chart, we perform a basic technical chart analysis of copper prices to try to gain some insight into copper's next move, which would also give us clues into the stock market's next move. As you can see, copper prices have broken below an important rising support line that began in early 2010. If this break holds true, it could indicate further declines in copper prices, and, likely, stock prices with slight lag. In addition, it's possible that copper is forming a bearish Head and Shoulders pattern variant (learn more about this chart pattern), and you can see the possible head and shoulders areas that are marked on the chart. Of course, if copper prices manage to break back above their rising support line and rally to re-converge with stock prices, immediate bearish bets are off (for now).
We recommend that you read our other recent blog posts because they are a helpful supplement to the current post: "Charting the Key Levels in the Nasdaq", "Is the SP500 Forming a 'Triple Top' Pattern?" and "Analyzing the Precious Metals Market: is a Bull Market Ahead?"
As usual with our our blog posts, we are not making any firm market predictions, because we are traders, first and foremost, and we trade with the prevailing market trend, instead of fighting it. The purpose of these blog posts is to show possible scenarios of how the market may play out, without saying that any one particular market scenario will play out.
If you wish to improve your trading skills, a great way to start is by attending our upcoming free webinar that will be taught by our Founder and CEO, Fausto Pugliese, who is a 12-time champion of the MoneyShow Traders' Challenge. This webinar is called "Why 80% of Traders Fail" and is on Thursday, March 28th at 12:00 pm (ET) and you can register for it by clicking this link.
Also, nothing within this post should be taken as investment advice or a recommendation to buy or sell any investment, as it is for educational purposes only.