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Dr. Copper Should Retire

One of the perennial favorite indicators used by the media of the market’s impending health is “Dr. Copper.” As a matter of fact, the WSJ was writing about it today:

COPPER BETS FLASH A WARNING

Despite a raft of good news—rising employment in the U.S., stronger growth in the euro zone and monetary easing in China—”Dr. Copper” believes the global economy is in poorer health than many think.

Among hedge funds and other money managers, bets that copper prices will fall have outpaced positions that would profit from a rise for 11 consecutive weeks. That is known as a “net short” position, and traders said its persistence in the futures market is reminiscent of a similar move that occurred in August 2008 ahead of the financial crisis.

“Dr. Copper is telling us that while the U.S. equity markets are being priced by such frivolous things as U.S. holiday retail sales, the global economy is experiencing a deceleration in growth [that will become evident] in the first half of next year,” said Jason Schenker, president and chief economist at Prestige Economics LLC.

Sounds pretty convincing, doesn’t it? After all, it’s in the WSJ; They’re talking about what hedge funds are doing (clearly the smart money) and they’re quoting someone with Prestige in their firm’s name.

The Dr. Copper premise is basically this, if copper (a widely-used industrial metal) starts to drop it means everyone is either cutting back on production or, as the case may be now, people are betting they will.

As an economic guidepost, copper prices historically have signaled recovery well ahead of other indicators, said Bart Melek, head of commodity strategy at TD Securities. However, Dr. Copper tends to give less advance warning of bad times ahead. That is due to the quirks of supply and demand: Manufacturers can be reluctant to cut back on the orders that drive copper consumption, while expansion of mines is expensive and time-consuming. That can keep prices buoyant even if the broader economy is souring.

So while Dr. Copper may be flashing a warning, the problem is it’s not really much of an indicator at all.

From Sentiment Trader:

We’ve discussed “Dr. Copper” several times in the past, and the correlation between extremes in copper prices and future returns in stock prices is poor.  It’s just not usually a very good predictor.

But let’s go back over the past 25 years for which futures prices are available and look at how the S&P 500 fared after other times copper fell rapidly into a bear market.  By this, we’re looking for a decline of 20% or more (in copper) within a two-month period…

Now, observing six incidents isn’t exactly a large sample pool (because of the limited dataset), but clearly the available data is not exactly convincing either. So, maybe it’s time to let the good doctor get some much needed rest from all of the media blitzing; Ya know, play some golf, take up meditation…

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Sentiment Trader