Friday, February 24, 2023
- Recession risk remains front-page news as rising interest rates weigh on economic growth. However, outside of economic data, rising copper prices over the last several months suggest the economy may be doing better than headlines suggest.
- Copper is widely considered a leading indicator for global economic growth based on its extensive use across many sectors, giving it the popular “Dr. Copper” moniker for its “PhD” in economics. Rising copper prices are generally associated with economic expansion and a risk-on backdrop.
- Technically, copper prices are trending higher after climbing out from a bear market late last year. Supply and demand dynamics appear supportive for the strength to continue. Historically, an uptrend in copper does not portend a recession.
- The copper-gold ratio chart is also trending higher, providing additional evidence the economy may be in better shape than expected. However, be careful what you wish for, as the copper-gold ratio chart is also positively correlated with 10-year Treasury yields.
There is no shortage of headlines reminding investors a recession is imminent. Yield curves remain inverted, manufacturing activity is contracting, the housing market is tumbling, and other leading economic indicators continue to decline, all while the Federal Reserve (Fed) continues to raise rates to combat historically high inflation. While inflation data is heading in the right direction, the downward trajectory of reduced pricing pressures may be turbulent, evidenced by today’s hotter-than-expected core personal-consumption expenditures price index. The stubbornly strong jobs market further complicates the inflation outlook, leaving the Fed with little justification to deviate from their higher for longer inflation fighting mantra.
Will all this tightening lead to a Fed-induced recession? Signs outside of economic data suggest the economy may be doing better than headlines indicate. One of those signs comes from copper, which is widely considered to be a leading indicator for global economic growth, given its extensive use across many sectors. Copper’s unique properties make it a fundamental raw material ingrained in nearly everything we use—from electricity, drinking water, heating and cooling systems, and transportation. According to Copper.org, the average single-family home uses 439 pounds of copper.
Technical Setup for Copper
As shown in the chart below, copper prices have been rising steadily following a 37% peak-to-trough drawdown that ended in July. Futures have recently reversed a downtrend and are trading above their 50- and 200-day moving averages (dma). Managed money futures in copper turned net long last fall and continue to build (total speculator long positions are greater than total speculator short positions). Of course, China’s reopening has helped drive demand, along with a drop in the dollar, the ongoing global energy transition, and a favorable supply backdrop. However, whatever the catalysts may be, a bullish uptrend in copper has not historically foreshadowed a pending recession. In fact, at the onset of the last four recessions, copper futures were trading below their 50- and 200-dmas.
Is Copper Pointing to a Rebound in Manufacturing?
Given copper’s classification as a leading economic indicator and its vast use in manufacturing, it may come as no surprise that changes in copper prices align closely with changes in the Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI). The chart below highlights this relationship using a 12-month rate of change comparison for copper (top panel) and the ISM Manufacturing PMI. As you may notice, major tops and bottoms tend to form simultaneously, although there recently has been a growing divergence due to the slowdown in manufacturing activity. While it may take more time for this divergence to be resolved, the continued strength in copper certainly helps make a case for a rebound in manufacturing activity. The ISM will release the February Manufacturing PMI data on Wednesday, March 1. Estimates as of February 24 point to another contractionary print of 47.8 (readings of 50 or less are considered contractionary).
Copper, Gold, and Treasury Yields
Copper is also often compared to gold for assessing risk appetite and where the economy is at within the business cycle. In general, rising copper prices are associated with an expanding economic cycle and a risk-on backdrop, while rising gold prices are associated with slowing economic growth and a risk-off backdrop. Combining the two in a ratio chart, as shown below, helps identify each risk appetite regime. The copper-gold ratio chart is currently trending higher and above its 50- and 200-dma, implying a risk-on backdrop. There is key resistance hovering overhead, and a breakout above this range would be a bullish sign for the economy. However, as shown in the lower panel, be careful what you wish for as the copper-gold ratio chart is also positively correlated with Treasury yields. While the correlation has weakened a bit recently, further upside in the ratio chart points to directionally higher yields, which could create headwinds for the equity market recovery.
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