If it isn't copper-bottomed, can stock rally be for real?

There is rejoicing in the equity markets. Global equity indices are rallying strongly, spreading euphoria among traders and investors. Then why is copper falling?

Copper often leads the equity market and a rally in equities without copper is suspect. Copper peaked on 9 February and has since lost 7.5 percent. On the other hand, the exchange traded fund (ETF) that tracks the Nifty in the US (Symbol: INDY) rallied nearly 5.5 percent from a recent low on 10 February and the S&P 500 rallied a little over 2 percent.

In the past, whenever copper sold off, the equity markets have followed in a few days. Copper is considered a leading indicator of the equity market’s direction as the metal shows the health of the economy. The relationship between copper, the equity market and economy has worked many times.

Copper is used in most manufacturing processes and a fall in its prices could indicate a drop in demand for the metal. This shows that manufacturers don’t need the metal as they foresee a slowdown in their business. As manufacturers slow down, so does the economy. Since the stock markets discount the future, they tend to fall a little after copper prices fall and vice versa in a bullish scenario.

In fact in December 2008, copper stopped falling and began to rally. However, the equity markets began to rally only a few months later in March 2009. Again, in February 2011, copper had begun falling, but the S&P 500 continued to rally and fell strongly a few months later.

Given the historic relationship between equities and copper, the current fall in the metal’s price should concern equity bulls. The markets have been creeping up for quite some time without a strong correction. Hence it would be prudent for bulls to take some profits.

Also let’s look a the chart of copper, the Nifty ETF and the S&P 500 (See chart below).

The top chart is of the copper index, the middle chart is Indy, which is the ETF that tracks the Nifty in the US, and the bottom chart is the SPY - the ETF tracking the S&P 500 index. Notice that copper has been falling for a few days, while both the Indian and US indices have continued to rise.

The other factor that bulls should be cautious about is that both the Indian and US equity markets are at turning points and could fall once again. And with copper already giving a bearish signal, the odds of an equity market selloff increase. The turning points in the equity markets are shown by red horizontal lines.

The red horizontal line in the copper chart shows that prices of the metal fell when it touched a level from where it had rallied briefly in the past. Previous rally points sometimes become selloff levels in future.

Aggressive traders can short the equity markets with stops a little above to prevent big losses if the rally continues. It is when the market looks the strongest or weakest that they turn.

George Albert is Editor, www.capturetrends.com