Written for Business Standard
January 25, 2012: The leading indicator of the equity markets--copper--is giving scrambled signals with a bullish breakout but lagging the markets.

Copper usually leads to equity market both up and down but is now giving confused signals. First a few words about the copper-equity market link. The relationship between copper, the equity market and economy have been clearly established time and again.

Since copper is used in most manufacturing processes a fall in copper prices show a drop in demand for the metal. This in turn indicates that manufacturers don't need the metal as they foresee a slow down in their business. As manufacturers slow down so does the economy. Since the stock markets discount the future, they tend to fall a little after copper prices fall and vise versa in a bullish scenario.

For instance in December 2008 copper stopped falling and began to rally. However, the equity markets began to rally only a few months later in March 2009. Again in February 2011 copper had began falling, but S&P 500 continued to rally and fell strongly a few months later.

In our column on December 14, 2011, we had mentioned that copper was forming a symmetrical triangle with a bearish bias. (Click here for Copper chart )We had also mentioned that if the price of copper breaks above the triangle, the bearish bias should be abandoned in favor of the bull. Earlier this month copper broke to the upside giving a bullish signal and took the equity markets up with it. It also broke another resistance level as shown in the chart indicating the prices will head higher. The symmetrical triangle and breakout is shown in the chart. We are looking at the continuous futures contract of copper (symbol: HG) with each contract controlling 25,000 pounds of the metal. 

The break out of resistance shows that copper is now headed to the next resistance zone between $4.12 and $4.21 and from past experience the equity markets should follow. In fact, last week both the US and Indian indexes were at resistance along with copper. It was felt that this would lead to both copper and equities falling. However, now with the copper breakout, it's likely that even equities will break out.

The bullish signal given by copper is however scrambled. Copper is supposed to lead the equity markets up.  But a step back to the longer term picture shows that's not the case. The Dow and NASDAQ 100 have reached the September 2011 highs from where they had fallen sharply. Copper however is 16% below the September 2011 level of $4.50. At the time of writing this article on Tuesday morning India time the price of copper was at $3.80.

The price action clearly shows that copper has been lagging the equity market off late casting doubt on the break out. At this time our bias would be neutral to cautiously bullish on copper and neutral on equities. But if copper shows substantial strength we would turn cautiously bullish on equities too.