What Is ‘Dr. Copper’ Telling Us?

Source: Thinkstock

Source: Thinkstock

So far, 2014 has been a somewhat turbulent year. While U. S. stocks are up 1.6 percent, as measured by the S&P 500, we have seen sharp and troubling declines in many developing markets. Many investors are concerned that weakness in these markets can potentially impact economic growth globally, although we haven’t really seen any signs of this. Weakness in economic data has generally been written off as “weather-related,” and stocks have cruised higher.

When the jobs data was released Friday, stocks didn’t really move, but there was one troubling reaction that deserves attention and that validates the aforementioned concerns: the decline in copper prices.

The price of copper fell by more than 12 cents on Friday, finishing the week at $3.09 per pound. This is the lowest level that we have seen since last summer. Copper has been relatively weak while other metals, such as gold and silver, have been rising, but the sharp decline in Friday’s trade suggests investors need to pay attention to what “Dr. Copper” is telling us.

The term “Dr. Copper” reflects the fact that copper is a heavily used metal in global economic activity, and movements in the price of copper are often leading indicators. A rise in the copper price means that more copper is being used and economic activity is picking up. A fall in the copper price similarly means that less copper is being used and economic activity is slowing down. The observation that copper price movements precede economic trends has led some traders to give copper an honorary PhD in economics.

We certainly shouldn’t take today’s price action in the copper market to mean that the economy is slowing down — it’s not that simple. However, we can look at this in a larger context of events and arrive at the conclusion that something isn’t right. First, we see a slowdown in economic activity in China and in several emerging markets. Second, we see political turmoil in Turkey and in the Ukraine. Third, many bellwether companies are seeing shrinking revenues and profits or slowing growth — from Costco (NASDAQ:COST), which reported weak earnings Thursday, to Wal-Mart (NYSE:WMT), which saw a double-digit decline in profits, to Apple (NASDAQ:AAPL), which is seeing its once robust revenue growth decline and its margins shrinking.

In this context we begin to see a pattern of weakness that infuses the decline in copper with a lot of significance. While I wouldn’t say definitively that the global economy is slowing or entering a recession, the decline in copper is just worrying sign, and investors need to be ready.

While the price decline might have been the result of profit-taking or misguided speculation, this is pretty unlikely given the price action we saw in some of the world’s largest copper miners. For example, Freeport McMoRan (NYSE:FCX) shares fell nearly 5 percent on volume that more than doubled the thirty-day trailing average. Southern Copper (NYSE:SCCO), which is more of a “pure” copper play that doesn’t have so much gold and energy exposure, fell 6.5 percent on nearly twice the average daily volume. Other large global mining companies fell as well.

Ultimately investors need to be very cautious going forward and pay attention to the price action in copper and in the mining companies. If it continues downward, I would begin to prepare my portfolio for economic weakness, which means selling a lot of stocks and looking for safe haven assets such as Treasuries and gold. Investors looking at these two assets should consider ETFs that offer exposure to them. For Treasuries I would recommend the iShares Barclays 20+ Year Treasury Bond ETF (NYSE:TLT) and the SPDR Gold Trust (NYSE:GLD) as simple and highly liquid ways to get exposure.