Bearish copper pauses to consolidate

Copper the leading indicator of the direction of the global equity markets has taken a breather from its bearish trend to consolidate since the middle of May 2011. It’s likely to resume the downtrend soon.

Copper is called Dr Copper by traders and investors, as it shows the health of the economy. It is a proven fact that the equity markets follow copper with a lag and copper had led equities during two key trend turns. In December 2008, copper bottomed and began rising. The equity markets in the US and India followed in March 2009.

Similarly, the early February 2011 copper peaked and began to sell off. The S&P 500 began to fall in first week of May 2011. The Sensex however peaked early in November 2010. Sometimes copper does not predict an equity market selloff but can forecast rallies with greater accuracy. A look at smaller time frames, however, shows that copper has predicted sell offs too.

Latest action on copper shows that the metal is moving into a consolidation pattern called a symmetrical triangle. A symmetrical triangle is a continuation pattern and since copper fell before it moved into a symmetrical triangle, one could see a further fall in the price of the metal. However, sometimes prices can reverse and move in the opposite direction and this will be bullish for copper. The price direction that copper takes may determine the future trend of the equity markets.

The fundamental reason for the fall in the price of copper is the inflation fighting measures adopted by China and India. China is a huge consumer of the metal and monetary tightening has led to a fall in demand for copper. Additionally, the growth in the developing countries is also slowing down. In the US the withdrawal of the Federal Reserve’s quantitative easing program is putting a downward pressure on copper. However, for copper to find price direction in the future it has to break out or down from the symmetrical triangle.

In a symmetrical triangle, price moves in a continuously narrowing range as buyers and seller battle to give market direction, but fail. The narrowing range forms a symmetrical triangle when we connect the peaks and valleys in price.

Once prices break out of the triangle they usually have explosive moves. Right now the copper is stuck in the triangle as shown in the graph. If the index closes outside the triangle on the downside, prices will head lower. On the other hand a close above the triangle’s borders will take prices higher. But since symmetrical triangles are continuation patterns, the greater likelihood is that price will head lower. Long term traders tend to avoid asset classes moving inside a symmetrical triangle. They take positions only after prices close outside the triangle.

How far the copper can go after the break from the triangle is estimated by the measured move. The measured move is the distance between the second touch in the triangle and the trend line on the opposite side. Aggressive traders use the pole as a measured move. The pole is the most recent peak in price to the lowest point in the triangle. Using a conservative measured move, copper prices can move by 8 per cent once outside the triangle. Using the pole to measure, indicates that copper could fall by 11.5 per cent.

The author is based in Chicago and is the editor of www.capturetrends.com