What copper prices may be saying about stocks

by Michael Tarsala, CMT

Copper prices may be giving us cues about where the S&P 500 is headed next, says Michael Arold, manager of the Covestor Technical Swing model.

More than any other industrial metal, copper is seen as a health gauge for the world's economy. The reason is simple: Big construction and telecom projects depend on copper. The metal is a standby for electrical, plumbing and telecom work.  So higher copper prices often are a reflection of increased economic activity.

In recent years, the biggest source of copper demand has been in China and emerging markets outside the U.S.

Here's a chart  that shows copper's relationship to the S&P 500:

Source: Stockcharts.com

You'll notice a few things about this chart. One is that the price of copper tends to move very closely in line with S&P 500. Also, copper has led the S&P 500 at several key turning points going back to the 2009 market lows. The green circles show when a rise in copper prices gave a cue to a coming stock rally. And the red circles show how a decline in copper preceded a move lower for stocks.

It hasn't worked every time. Notably, copper failed to give a signal about the stock rally that started last fall.

Right now, the chart suggests something has to give. Copper prices stalled in early February and have been moving sideways ever since, while the S&P 500 surpassed last year's highs.

Simply put, Arold would feel a lot better about the market rally right now if copper were to break out from its sideways movement. Otherwise, copper may be giving a signal that stocks are also due to move sideways.

Here's were China comes in: It is very much tied to copper, and remains one of the keys to global stock direction. Should the Chinese government indicate it will start cutting interest rates, Arold believes that basic material and energy could be leading stock sectors in coming months.

So first, he says to watch if copper will break higher from its sideways price movement. Then, keep an eye on the XLB, the materials SPDR, as well as the energy SPDR, the XLE.

But it could move lower, as well. Arold will be watching the $3.70 level on copper closely this week. He says a breakdown below the triangle shown in the chart above would be a negative for copper, as well as a further warning for stocks.

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