How a widely used industrial metal takes the global economy’s pulse
Want to measure the pulse of the global economy? Ask Dr Copper, or so the adage goes. Copper is all around us. You need it to build a house, a car and a hairdryer. The red metal is even one of the most intensively used raw materials in the green energy revolution — more electrical motors, more battery packs (but fewer internal combustion engines) means more copper wiring. So demand for copper ebbs and flows with the ups and downs of the business cycle.
An expanding economy means people are building more houses, exporting new cars, buying more hairdryers, and therefore using more copper. In fact, as a crucial, core component of many products, it is often ordered by manufacturers well before the final product comes out of the assembly line. That’s why a decrease in the demand for copper can provide an early indication of weakness in global activity.
A more timely prognosis?
Data confirming economic activity is generally only available with a considerable time lag. It can take at least six weeks for the first, error-prone estimate of quarterly global domestic product (GDP). Copper is bought and sold so often that its price changes by the second. This instantaneous pricing in response to changes in supply and demand is thought to give a much timelier prognosis on the health of the global economy (figure 7).
Figure 7: A measure of economic health
Copper prices have provided an indication of upcoming recessions in the past but they are not always a reliable predictor.
Source: Datastream and Rathbones
What is Dr Copper telling us at the moment? And is he really qualified, or something of a “quack”?
The price of copper fell by about 15% in 2018. However, the plunge occurred entirely between June and August. It rose by about 5% over the final three months of the year, despite fears about slowing global growth riling most financial assets, and it is still 4% higher than it was 18 months ago. Copper prices are volatile and using a simple statistic, such as the annual change, would give many false signals of a contraction in economic activity. Copper prices also respond to factors other than demand and supply.
A recent study by the Bank of England found that a predictive model based on quarterly changes in industrial metals prices and the previous quarter’s GDP growth did a better job at predicting next quarter’s GDP growth than a model that used last quarter’s GDP growth alone. But only just. That said, metal prices did predict the surprise increase in global GDP growth in early 2016. Few forecasters at the time expected a rise in global growth.
Ask Copper Yi sheng
Back then, forecasters’ pessimism in part focused on China, which accounts for 50% of global copper demand. In 2017, China completed 77 of the world’s 144 new supertall buildings (over 200 metres high). By comparison, there are only 113 buildings in New York City’s current skyline in that league. Dr Copper is arguably more Copper Yi sheng.
In fact, we note a very strong correlation between the price of copper and our ‘nowcast’ of Chinese GDP growth over the past few years. Our ‘nowcast’ uses data less susceptible to error and manipulation to calibrate a more accurate gauge of activity than the official GDP numbers.
It currently suggests growth is actually close to the official figures, although that certainly wasn’t the case in 2015 and 2016. Interestingly, we find the strongest correlation when we ‘lag’ our activity indicator by six months. In other words, the price of copper seems to respond to Chinese growth with a six-month delay.
Perhaps we shouldn’t rely too much on Dr Copper’s reputation for giving us an early diagnosis. High inventories are weighing on industrial output, and export growth has lost momentum, but the latest set of figures reported a modest improvement in spending elsewhere. Tension between America and China had started to thaw as 2018 drew to a close, but we don’t believe the trade war is over and remain vigilant.