The Copper/China Correlation Myth
01/05/2011 12:04 am EST
Analysts are constantly talking about how copper is the ‘tell’ on the Chinese economy. They may be using Freeport McMoran Copper & Gold (FCX), or the iPath Dow Jones UBS Copper ETN (JJC), or the futures or physical commodity itself. As FCX rises, they will say that it is due to Chinese demand for copper. Or as copper futures fall, they will talk of the slowing of the Chinese economy. Do the data back this up?
Measuring the Chinese Economy
There are two measures that can be used as a proxy for the Chinese economy: Government statistics and the stock market, specifically the Shanghai Stock Exchange Composite Index, SSEC. As the former is issued by a government running a command economy where information is controlled, I will ignore it. They can tell us whatever they want us to believe. This leaves the Shanghai Composite as our measure. Below is a ratio chart of the Shanghai Composite to copper futures over the last year on a daily basis.
This chart shows a steady strengthening of copper against the SSEC (or conversely, a weakening of the SSEC against copper) over the 12-month period. If the Shanghai Composite and copper were 100% correlated, this chart would be a level line from left to right. Think about this for a moment: This simple chart tells that copper is strengthening in price faster than the Chinese market. Chinese demand is not solely driving the price higher.
NEXT: So What Is Driving Copper Prices Higher?|pagebreak|
Then What Is Driving Copper Higher?
If you were to use the S&P 500 ETF (SPY) and iShares MSCI Emerging Markets ETF (EEM) as measures of the US and emerging economies in the same way, you find a much tighter fit with the rise in copper. Below is a one-year performance chart of copper against all three markets.
There is certainly a correlation between all four lines, but notice how the returns for copper are much tighter with those of the SPY and EEM than that of the SSEC. It appears that growth in the US and other world markets may be a bigger consideration in the price of copper than the Chinese market. Also, copper returns outpace all three markets.
And something else interesting pops out of this chart. The chart below resets the time frame to the last three months to make it more distinct.
Looking at the returns of copper compared to world markets over the last three months, they appear tightly correlated until the end of November 2010. At that point, copper leaps higher as the SSEC falls off and the SPY and EEM move only slightly higher.
There are lots of reasons why this could happen. Some of them—like increased demand from other parts of the world—would be healthy for copper, if they were the case. What seems more likely are two scenarios that are not so healthy for copper prices in the short term. These are increased demand for copper due to creation of a new ETF, and supply constraints from short-term mining issues. Both of these scenarios would suggest that copper is in short supply and the price may have run higher due to that constraint.
A bubble? Not really, but a short-term acceleration of the trend higher. This suggests that when a new equilibrium is reached, a short-term correction back to trend growth could occur. That correction may have started today. Something to watch for to take advantage of the dip.
By Gregory Harmon of DragonflyCap.com.