Copper Correlation To China: Not So Much Lately

Analysts are constantly talking about how Copper is the ‘tell’ on the Chinese economy.

They may be using Freeport McMoran (Ticker: FCX) or the Copper Exchange Traded Note (Ticker: 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 the futures (symbol HG) fall they will talk of the slowing of the Chinese economy. Do the data back this up?

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 the government running a command economy where information is controlled, I will ignore it.

They can they us what ever 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.


Photo: Greg Harmon, Dragonfly Capital

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 charts tells that Copper is strengthening in price faster than the Chinese market. Chinese demand is not solely driving the price higher.

Then Who is?
If you were to use the S & P 500 ETF (Ticker: SPY) and Emerging Markets ETF (Ticker: 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 1 year performance chart of Copper against all three markets.


Photo: Greg Harmon, Dragonfly Capital

There is certainly a correlation between all 4 lines but notice how the returns for Copper are much tighter with those of the SPY and EEM than the SSEC. It appears 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. Something else interesting pops out of this chart. The chart below resets the timeframe to the last 3 months to make it more distinct.


Photo: Greg Harmon, Dragonfly Capital

Looking at the returns of Copper compared to world markets over the last 3 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.

Copper Bubble?
There are lots of reasons that 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 that 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.

This post originally appeared at Dragonfly Capital.


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