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Commodity Investing

Crude Oil Futures and Copper Prices: The Ultimate Indicator?

Crude Oil Futures and Copper Prices: The Ultimate Indicator?
“Gina Martin Adams, a strategist at Wells Fargo, likes to look at a copper in comparison to another commodity known to have its own economic gauge… oil.”

For years copper has been touted as the gauge for the world’s economic health, with many experts referring to it as “Dr. Copper,” stating it has a Ph.D. in economics.

Copper is rather inexpensive, tremendously abundant and has numerous useful properties.

As an excellent conductor of heat or electricity, and corrosion resistant, it is used in various industrial applications.

Any emerging or expanding industrial economy relies on copper from plumbing to electrical wiring, to air conditioners and radiators.

And during periods of economic growth you normally see the rise of large construction and telecommunication projects, infrastructure updating, medical and energy expansion, and technological developments all that entail the use of copper.

As demand for the copper goes up, so does it’s price.

The idea is simple, by watching the price of copper and what the globe is doing with it, experts can gauge if the world economy and emerging industries are healthy and growing.

Does the Gauge Always Work?

To put it simple… no.

The “Dr. Copper” rule is not a bulletproof theory. Yes, there are many times in the past when copper prices grew along with improved economic health, but there have been several times when this was the opposite.

And while copper can still continue to be one of the most useful gauges for detecting economic health, Gina Martin Adams, a strategist at Wells Fargo, likes to look at a copper in comparison to another commodity known to have its own economic gauge… oil.

Adams compares the ratio between copper and crude-oil futures to the S&P 500 to gauge the health of the global economy; she calls it the copper-to-oil ratio.

She notes that when copper is accelerating faster than oil prices, stock tend to do particularly well. But at times when oil prices outpace copper prices, economic growth tends to fade.

And recently Adams has seen the latter case of oil gaining on copper.

Copper Prices

You can see in the chart above that since this year’s peak on February 6, the ratio has started to fall.

So while many can use the “Dr. Copper” theory to tout that copper has risen 12.5% in 2012 and will continue to rally with the economy, we also can use the copper-to-oil ratio to get another perspective.

Oil is used to transport goods all over the globe, and when the price of oil starts to rise, so do the cost of goods, which has a negative effect on the economy.

Comparing two different commodities that give insight to the health of the global economy gives investors a more rounded picture.

While oil has only risen around 3.5% to date (less than copper) the oil-to-copper ratio is losing steam, signaling that the 2012 rally in U.S. stocks could start to fade.

Investor should keep an eye on both copper and oil prices.  If copper continues to outperform oil the rally could continue, but if oil start to catch up to or outpace copper we could be in store for a slow down.

Good Investing,

Ryan Fitzwater

*The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.

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