There has been quite a number of articles (one, two, three) recently showing a strong correlation between copper price and the stock market, and how the decoupling since May 2012 where copper has been in a consolidation range versus the continued stock market uptrend, is a leading indicator that the market was due to head down.
The argument is that copper is the most used metal for industrial purposes, so the price of copper is a proxy for the strength of the economy. And if the strength of the economy is not improving, copper prices would not be going up, and the stock market should not be going up either. While the market did correct from May 20, 2013, is that really due to a stagnant economy proxied by copper prices?
One interesting thing you might note from the charts is that most of them start their charts from 2008. Tom McClellan wrote an article (link here) which is more illuminating. McClellan’s chart starts from 2002, and showed that the relationship between copper and the stock market does not always show a good correlation. From 2002 to 2008, there is no consistency in the relationship. McClellan concluded that the strong relationship between copper and the stock market in the recent years is just temporary.
This is an example of how a strong relationship between two variables can be seemingly established by limiting the field of vision. While the argument sounds very compelling, as with most things, it is usually not as simple. For example, one of the articles noted that the copper inventory levels at the LME (London Metals Exchange) and the copper industry’s own demand/production are more important in the interpretation of copper prices compared to simply asking whether the economy is strong or weak.
In my earlier blog post, I also noted that Kyle Bass cautioned against assuming that Japanese equity prices will go up simply because the Yen is depreciating. Depending on another variable to ‘drive’ the instrument you are trading is always tricky, just like trends, they work, until they don’t.