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A Developing Trade in Copper Might Confirm Bearish View of Equities


The copper market is offering signals about where price will go during the next two years and what the surrounding economy is likely to do during the same period.


Why Copper Price Should Decline

Certainly one can make a case that copper is overpriced this year based on fundamental considerations. Worldwide and particularly in Asia, demand for copper appears to be slowing, while stockpiles are increasing. Since 2008, China has been the single greatest user of refined copper among all nations, until recently accounting for almost 40% of global use [1]. However, Chinese consumption of the metal in 2012 is believed to have dropped by almost 9% from the previous year, reflecting a likely slowdown in industrial and infrastructure development there [2]. Does this foretell a minor pullback in the price of the metal or a more substantial disturbance in overall economic activity? Based on what we know so far, seeing price go down or continue sideways seems more likely than seeing it climb higher.

However, unless you are at the helm of a hedge fund with large coffers, trading based on fundamentals requires a mastery and patience that few have. It helps to turn to technical considerations to find the dates and price levels that might represent turning points. We believe the copper chart reveals some of the answers about where price is going, and when it will start to go there.

Even though the price of copper rose impressively from 2009 to early 2011 and made a new high, the move was almost certainly corrective, as revealed by its clear three-wave structure. Also, in late 2011, price overlapped the area of the first wave (labeled 'A'), thus ruling out the possibility that a 5-wave impulsive move was forming in the upward direction. According to Elliott Wave conventions, the only way price could increase very much from the present level would be in another upward corrective leg, producing a larger complex corrective pattern of which the 2009-2011 move was just the first part. However, the 2011 high was already so far beyond the previous high of 2008 that an extended correction upward is unlikely. Besides, a corrective move rarely pushes into uncharted price territory for very long.

While a renewed push upward is unlikely, so is continued sideways action. The envelope of price extremes has been converging since late 2011, suggesting that some kind of breakout move is needed.

The alternative is that price is in the process of tracing some net-downward corrective pattern after the 2011 high. If that is the case, then the downward move should be similar in magnitude to the downward move in 2008 and the upward move that lasted from 2009 to 2011. Based on the size of the down move so far, it doesn't look complete. Therein lies the potential trade in copper as well as the signal about larger economic activity. But when might copper resume its downward move, and from where? Should we wait for a better retrace? More clues come from a closer examination from an Elliott Wave perspective.

After the high of early 2011, price headed downward in what looks like another three-wave move, which we have labeled the 'A' wave. Price then went into a consolidation pattern with converging range – something that looks very much like a classic Elliott Wave triangle. If it really is a triangle, then price should continue downward in wave 'C' after the triangle is complete.

Note, it is very important to think of this analysis as describing a potential trade or a potential move in price. Price fluctuations in any market result from the very facts that trading is difficult and that predictions of price moves are far from certain. Thus, when you identify a potential trade setup, as we are doing here, it is equally important to identify the market signals that will tell you when your expectations are wrong. Even without considering technical analysis of the charts, one warning sign would be any significant improvement in economic indicators reflecting industrial and infrastructure development, especially in China and developing Asian nations. We will mention another possible warning signal in the next section of this article.
No positions in stocks mentioned.
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