If the Dollar weakens, copper’s price increases. Are we sure it is always like that? Is the Dollar’s depreciation enough to justify purchasing copper from those who hold foreign currencies? We could say the answer is yes, but instead it has not been this way for extended historical periods.
As widely known, copper is a dollar-denominated metal. This means that a depreciation of the U.S. currency makes purchasing copper more convenient for those who hold foreign currencies. Therefore, if the Euro/USD exchange rate increases, we could expect an increase in copper’s demand and, consequently, in its price. in other words, we expect a positive correlation between the Euro/USD exchange rate and copper’s price. We could say the opposite about the dollar Index. It measures the strength of the Dollar with respect to a basket of the main world’s currencies, and the higher the index is, the stronger is the Dollar.
Chart: Correlation of Copper price (LME cash) with Euro/USD and Dollar Index – Source: LME, Ekuota
In order to have a better comprehension, we take a look at the chart above, with the blue line that indicates the Copper-Exchange rate correlation’s trend and the red line that shows, instead, the correlation between copper and the Dollar Index. As the chart clearly shows, the two trends almost perfectly mirror each other.
Now it’s time to see if our expectations are fulfilled, looking at the empiric data. In the period considered (september 2011-June 2018), the average daily correlation between Copper and the Euro-Dollar exchange rate and between Copper and the Dollar Index are respectively equal to 0,2962 and -0,3828. We could say that we got what we wanted, as we had a positive correlation with the EUR/USD exchange rate and a negative one with the Dollar Index. If we look deeper, however, we can notice that there was a period of strong positive correlation with the Dollar Index, with a corresponding phase of negative correlation with the Euro-USD exchange rate. We are talking about the window between May and June 2017.
Between May and June 2017, the Euro/USD cross weakened, going over the 1,2 level. Following this depreciation, metals and commodities generally slowed down, in contrast with the historic trend. According to Shelley Goldberg’s “The Dollar and Commodities break a Long-Standing pattern”, published by Bloomberg in July 2017, there would be different reasons why this trend inversion happened, which would mostly be due to Trump’s policy. We can recall the most important reasons, which are the infrastructural investment lower than expected and the will of renegotiating the NAFTA agreement. Donald Trump’s campaign had been centered around an infrastructure’s recovery and on the promise of building a wall on the border with Mexico. However, during the first year of presidency, Trump could maintain his promises only partially and, therefore, the commodities’ demand was lower than expected. The initial positive effect of Trump’s election on commodities’ price slowed down almost immediately, bringing to a reduction in copper’s price. Secondly, Trump had the goal of renegotiating NAFTA’s agreements and imposing tariffs on commodities’ imports from Mexico, Canada and other allies. Anticipating this event, commodities’ prices had gone up and the Dollar had appreciated, before inverting the trend when Trump could not find at first the Congress’ support he needed.
Chart: Copper price (LME cash) and its Correlation with Euro/USD – Source: LME, Ekuota
Focusing now on the chart above, we can find a great number of useful indications. Between the end of 2015 and the first months of 2016, copper’s price sharply decreased, reaching minimum levels slightly above 4300$/ton. The reason of this unpredicted reduction is the weaker demand coming from China, which, alone, is responsible for half of the world’s demand of copper. As soon as China’s economy slowed down, after the elevated growth rates in 2010-2015, the demand for metals decreased consequently. The supply remained unchanged, determining a fast and unforeseen fall in copper’s price, which made the main smelters drastically cut their production. In the same period between 2015 and 2016, the Dollar experienced a low volatility, moving into a 1,05-1,15 range. The mix of a huge reduction in copper’s price and the Dollar’s stability caused a fast decrease in the correlation between this two factors. After the high levels reached in the last quarter of 2015, getting close to 0,9, the correlation rapidly went under 0,2.
Chart: Copper price (LME cash) in Euro and USD – Source: LME, Ekuota
Changing for a moment the reference currency, the chart above shows how copper’s price went below 4000€/ton between 2015 and 2016, a level not reached since 2010. This means that demand went down drastically, not because of a strong Dollar, but mostly due to the weakness of the copper demand.
The lesson we can learn watching the historic trend of copper’s price and its correlation with the Dollar is that important macroeconomic events can have a huge influence of the correlation between the US currency and the main commodities. Looking at the final part of the opening chart, we can notice that the correlation, which in 2018 has reached levels close to 0,9, looks to be inverting the trend and to be converging to the average. We have also seen how historically a trend inversion signals an imminent breakdown in copper’s price. The last part of 2018 will be crucial for metals, which will respond to the tariffs imposed by Trump’s administration not only on China, but also on its main trade allies. Considering all the theoretical, I would like to end with a very practical take-away: if a large copper purchase is in the horizon, differing it as much as possible could be a risky strategy, but it could prove to be winning, if we believe that what happened in the past could repeat. All of the conditions for the 2016-2017 scenario could happen again. Even if we know that copper is influenced by factors which aren’t related with the Dollar, we have to consider a mix of macroeconomic turmoil and inversion in the correlation as a huge wake-up-call.
Chart: Copper price (LME cash) and its Correlation with Dollar Index- Source: LME, Ekuota