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The Wisdom of Copper

The Wisdom of Copper

A hundred years ago a dressed steer was offered as a prize at an English county fair. Contestants paid one penny and were required to guess the weight of the animal. After the winner claimed his prize, mathematician Frances Galton averaged all the entries. To his surprise, he found the average of the crowds’ guesses was closer to the steer’s weight than the winning entry.

This led to the theory known as the Wisdom of the Crowd, which postulates that the crowd is collectively wiser than any individual within it.

Why is this important to investors? Prices – of shares, indices, commodities – are a mass expression of opinion. The price is the “average” expectation of all those buying and selling in the market. This also speaks to the sincerity of the opinions expressed – buyers and sellers put their money behind their opinions. Astute investors can use this mass expression, this wisdom, to gauge current market sentiment. And at the moment, copper is sounding a clear warning note.

Here’s the weekly chart of copper prices:

20151117 copper

Copper is used in almost every industry, from construction to computers. Since the peak of commodity prices in 2011 copper has more than halved in price. While there are significant rallies along the way, the overall direction remains downward. This week, copper is under further pressure and trading at six year lows.

A stronger USD is dragging on commodity prices, and copper is no exception. However the size of the fall points to other drivers of the weakness beyond the currency effect. In my view, the current selling suggests industrial sentiment is still deteriorating after weaker trade and inflation data from China.

Stock sectors most affected by industrial sentiment include Materials and Industrials. How investors use the information from the copper market will depend not only on their existing holdings, but also on their view of the investment world.

Technical analysts are fired up about the copper chart. This is because it is now trading at a Fibonacci level (in technical terms, it may be completing the fourth leg of a butterfly pattern). This means it is at a decision point, and the near term moves could indicate the future for copper and global industrial sentiment.

If copper now drops through the $2.00 per pound level it may mean a move towards the post GFC low around $1.25 is on the cards. Naturally, this sort of fall in copper prices would not occur in a vacuum. The accompanying weakness in industrial sentiment would see shares plummet as well. Investors concerned about this scenario should be ready to act – to sell shares, sell CFDs and/or buy put options.

On the other hand, if copper prices rally from this decision point, the implications are profound. Of course, this would signal an improvement in industrial sentiment. A lift in prices from current levels would also suggest the commodity cycle has bottomed, as copper is a very influential industrial commodity. By implication, it would also mean that growth in China has stabilised. Copper potentially has a lot to tell investors and traders.

If copper is turning it will trade above $2.20 a pound, likely signalling a trend change. Investors might also treat this as a signal to buy materials and industrial stocks, particularly where portfolios are underweight these sectors.

Given the strength in industrial shares over the last two years, some investors may consider materials, and possibly energy, as the sectors most likely to reveal bargains. When a cycle turns there is no need to be too clever. Given the huge falls in these sectors, investors may spot bargains even among the global blue-chip plays, allowing for lower risk exposures.

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