Over the past decade or so, most industrial commodities have traded in sympathy. Generally speaking, economic lifeblood commodities such as copper and crude oil usually saw their fortunes rise and/or fall at the together. The direction these two key commodity trees would sway was usually was dictated by the prevailing macroeconomic winds. This year, however, the copper and crude relationship has broken down—and that’s a clarion call savvy traders need to listen to.
The breakdown of the copper/crude relationship has been especially acute over the past four months, as copper and West Texas Intermediate crude oil, or WTI crude, have basically traded in opposite directions. In the case of copper, we’ve seen a pronounced drop in the industrial metal, while the fate of crude oil has been accentuated by a bullish run to new 52-week highs.
Last week, however, we’ve seen a distinct reversal in each fund’s respective price trend, as copper has made a big move higher while oil has come back down off its highs. This reversal is important, because it could be the first clear signal as to which areas of the world will see relative outperformance going forward.
The charts here of the iPath DJ-UBS Copper TR Sub-Index ETN (JJC) and the spot price of West Texas Crude Oil ($WTIC) show the divergence between these two industrial commodity bellwethers.
Now, broadly speaking, WTI crude is a proxy for U.S. economic growth, while copper is a proxy for Chinese economic growth. These two commodities tend to rise and fall with the pace of their respective economies, and can often indicate periods of acceleration or slowing in those economies.
The return numbers this year bear that reality out.
As of the Thursday, Aug. 8, WTI crude was up about 14% year-to-date, while the S&P 500 was up about 18%. Conversely, copper was down was about 10% while the Chinese equity market is down approximately 9.8%.
What is copper telling us?
During the past week, however, copper looks to have broken a downtrend that’s been in place since mid-February. That move is due almost exclusively to the recent stabilization in Chinese economic data, and specifically, the better-than-expected Chinese trade numbers we saw this week. Meanwhile, WTI crude’s big run appears to have traced out a “double-top,” implying that, at least in the short run, the rally is over.
As you likely know, so far in 2013, the best trade going was to be long U.S. equities, and underweight the rest of the world. Recently, however, economic data from around the world has been picking up, particularly in the UK and Europe. So, the question now is this: Is copper, by breaking out, telling us that the best way to outperform is to reverse the trade by getting long China, Europe, natural resources and emerging markets (all laggards so far this year), and becoming underweight the US market?
We suspect that on a relative performance basis, a strong case can be made that these areas of the globe will outperform the U.S., especially if global economic data continues to improve.
Think about it this way: Year-to-date the S&P 500 is up 18%, while “Europe” is up about 6%; China, as mentioned, is down nearly 10%, and emerging markets, as measured by the Vanguard MSCI Emerging Markets ETF (VWO), are down about 12%. So, from an incremental return standpoint, what’s more likely: the S&P 500 rallies another 18%, or some of these markets play catch-up?
Hey, copper and crude are trying to tell us something, so let’s respect their wishes and give them thoughtful consideration.
Tom Essaye is founder and editor, and Jim Woods is contributing cditor, of The 7:00’s Report, a daily investment research note that provides need-to-know analysis of markets, economics and geopolitics.