Copper's breakout may see a short bull run next week

By George Albert

Copper, a lead indicator on the future direction of the equity markets, established a short-term uptrend last week, which means that the bulls are likely to get some relief.

There is a fundamental reason why the copper markets lead the equity markets. Copper is used in several manufacturing processes. Hence, when manufacturers get bullish, they buy copper in anticipation of increased production. This leads to a rise in the price of copper.

The equity markets, when they see a rise in copper prices, conclude that the economy is getting better as manufacturers may be planning to increase production, leading to a rise in share prices a few days later.

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The lagged effect of copper on equities has been proven in the past. Copper had stopped falling in December 2008, but the equity markets continued downwards till March 2009 in the US. Even the Indian stock markets fell in March 2009, but not to a new low.

[caption id=“attachment_70830” align=“alignleft” width=“380” caption=“Copper, on the other hand, began to slowly climb and finally broke out to rally strongly in March 2009. Reuters.”]  [/caption]

Copper, on the other hand, began to slowly climb and finally broke out to rally strongly in March 2009. That’s when the equity markets, both in the India and the US, bottomed out and began the huge rally.

Last Thursday copper again broke out and rallied and this is expected to pull the stock markets up. A look at the combined copper and S&P 500 chart (View Chart) shows that the copper exchange-traded fund (ETF) chart in green broke out to a new recent high but the S&P 500 ETF chart in orange has yet to get there.

The fact that the equity market follow the copper market is also seen on the chart. Notice that copper stopped rising after 7 July 2011 as marked by the vertical line. But the S&P 500 continued to rise. However, the lack of support from copper eventually led to a selloff in equities.

The Indian stock markets sold off on Friday into a decent level of support. Support levels are areas where the demand for stocks exceeds the supply of stocks, which generally leads to a rally in prices.

The Sensex closed at 15,848 on Friday and the support zone is between 15,850 and 15,500 View Chart . The rally in copper and Sensex at the support level increases the likelihood of a bull run in the markets next week. The support level on the Nifty is between 4,670 and 4,761 and the index closed at 4,747 last Friday. View Chart

However, note that the current bull signal is for the short to medium term only. This is so as copper broke out of its trading range after a couple of weeks. The breakout that led to the huge rally in equity in March 2009 was after trading in a range for about three months.

A sustained rally in copper is needed to take the equity markets up. A selloff in copper will kill any rally in the equity markets. But the US Federal Reserve is standing by to start the money printing press in case there is a further economic weakening. This will give a boost to both copper and the equity markets - at least temporarily.

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George Albert is Editor at www.capturetrends.com