Since 2012, it has also had a higher correlation to forward 5y5y breakeven expectations than oil, suggesting that copper is also a better barometer for the broader pricing environment. While attention has focused on oil’s effect on inflation, our economists have pointed out that the decline in gasoline prices should provide a much-needed boost to real income and consumption in the near term.
Against this backdrop, asset price movements and correlations are implying that:
- Global growth should recover as the ratio of copper to Brent oil has risen notably, which historically has been correlated with a pickup in growth and a rebound in equities.
- Medium-term inflation expectations in Europe and the US have declined in concert with shorter-term cyclical factors such as falling oil, with correlations at extremes; forward breakevens have likely overshot, potentially due in part to scepticism that central bank actions will be able to raise the subdued inflation environment.
- Incremental demand will have to come from outside the US to absorb global excess capacity as US growth continues to run at a solid pace (Q3 GDP estimate 3.0%), hence the higher correlation of 5y5y inflation expectations to EM and Europe growth proxies.
Oil versus copper: why global growth is likely not as bad as feared…
Many investors point to the collapse in oil prices as evidence that global growth is rolling over, but rising supply has also contributed to the 25% decline in Brent. Copper, on the other hand, has had a much more measured 7% decline since June, despite weaker growth outside of the US, particularly in China.
Oil looks to be reconnecting down to the level of copper. Plotting Brent oil and copper since 2011 shows that the two moved closely together until summer 2013, when Libyan production began its decline (Figure 1). Long positioning in WTI futures also surged around that time on Syria/supply fears. The oil-copper disconnect remained until June, when Libyan production resumed, but oil prices have now fallen below those implied by copper, as producers have been discounting to maintain share (see our commodity strategists’ commentary in Standing on a broken floor). Still-significant net long positioning in WTI futures amidst producer competition suggests that WTI weakness may not be done.
Copper’s slide is less than half of recent sell-offs and prices have been stable in October.
Peak-to-trough declines in copper have averaged 18% during the slowdowns since 2010; copper declined 8.7% from the July 3 high. Importantly, copper is only off a maximum of 2% in a volatile October thus far, compared with 7% for the S&P 500 and 13% for oil. Copper prices have likely been supported by tighter supply dynamics due to Indonesia’s export ban and the lowest warehouse stocks since 2008. Other industrial metals prices have been relatively resilient through the market volatility, with aluminium up YTD.
Copper implies that growth remains sluggish, not another leg down. Copper has been a solid indicator for world IP growth historically (Figure 2). Copper weakness in early 2014 signalled the notable deceleration in production globally. The decline since June points to a continuation of the modest YTD range for IP growth.