Copper signals red for bulls

Copper the leading predictor of the global economic health has reached a key area of technical resistance along with other indicators showing weakness.

The Dow Jones-UBS copper index entered an area of resistance after a long rally. The area of resistance is in the range of 410 to 450 and the index closed last Monday at 416. The price of copper is seen as a leading indicator of the global economy as the metal is a necessary input in manufacturing several goods. So, as prices of copper rise, the market predicts that manufacturers are buying up the metal to increase production, resulting in a rally in the global equity markets.

This correlation may not work all the time, but has several times in the past. So as copper prices reach resistance from where they can turn, it's important not only for copper bulls to be cautious, but for longs in other markets to ease off the accelerator.

Let us take a couple of examples that shows copper leading the equity markets. The copper index hit a resistance area of 395 during the week ending April 9. A few weeks later on the week ending April 23, the S&P 500 saw a fall. The Sensex too fell along with copper in April. In 2009, between January and February, copper went into a consolidation phase, while the equity markets continued its negative trend. However, in March copper broke out of its consolidation range, which resulted in the bottoming of both S&P 500 and the Sensex and subsequently a rally.

The resistance area of 410 to 450 that copper has entered is the area from where it fell in October 2008 to tank all the way down to the 150 area. It would be imprudent for bulls to ignore this resistance level. In addition, the technical indicator, commodity channel index (CCI), is showing negative divergence which signal upcoming weakness. A negative divergence happens when prices move to new highs but the CCI does not. A look at the chart will show that prices moved higher recently, but CCI did not.

On a fundamental level too, copper seems overpriced now. For instance, the price of copper was in the resistance range of 410 to 450 in May 2007. The global economy was booming then, unlike now. Hence, for the price of copper to be at economic boom levels, when the global economy is still healing, seems incongruous.

There is however a note of caution in using copper to predict a fall in the equity markets. The prices of commodities are driven not only by economic demand but also by the value of the dollar. If the value of the dollar continues to fall copper will break out of resistance and continue to rally. It is hence prudent to look at the dollar as well to gauge the direction of copper. Right now the dollar is near some major support areas, while copper and the equity markets at resistance. This is a good confluence for copper bears.

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