In the modern age, copper is so essential across multiple industries that its price is widely seen as a proxy for modern development and economic vitality. Similarly, oil has long been the lifeblood of current economies by generating energy to make development possible. Since copper can be considered a barometer of global economic health, it is no surprise a correlation to oil and gas demand exists as a healthy, growing economy requires more and more energy. Unfortunately, an unexpected divergence has occurred since the beginning of the global pandemic. Luckily, there appears to be market energy building for a large commodity price upcycle in which crude closes the gap and corrects upward to its industrial cousin, copper.
- Historically, the price of copper has been correlated to the price of oil since they are both often used during times of increased development and economic growth. The two commodities are also very inter-related because energy costs make up about 30% of the copper extraction process and 50% of the smelting and refining process. Since the materials are needed for large industrial projects and infrastructure growth, both commodities are commonly used as barometers for increased global economic development when prices rise and a precursor to economic stagnation when prices fall.
- While copper and oil commonly follow a similar trend, divergences can occur until economic and market conditions correct the price imbalance. These instances occurred in the mid-2000’s when China was rapidly developing its infrastructure, during the 2008 financial crisis when economies of the world were in turmoil, and at the end of the U.S. shale revolution until the 2014 oil price collapse brought the two commodities back into unison. Following the COVID pandemic in 2020, the price of copper futures has recovered much faster than oil causing another divergence that may be a bullish indicator for crude.
- There are four major factors that indicate crude will likely be the commodity to correct towards copper price and not the inverse:
- Fundamentals show crude supply and demand imbalance has caused stocks to fall back within the 5-year range and demand is continuing to outpace supply.
- Financials indicate oil is currently very undervalued when compared to everyday goods, equity markets, and other commodities like gold and copper.
- Biden’s administration is not focused on expanding U.S. production of fossil fuels, investment has shifted to projects focused around ESG, and OPEC+ will continue regaining market share while recuperating lost revenue – all contributing to reduced supply.
- Technicals display crude futures converging on several decade-long structures and key volume benches which could result in a strong price movement either up or down.
- Copper demand is continuing to grow in China as the country comes out of restrictions from the pandemic. As other countries follow suit and begin post-COVID economic recoveries, raw materials like copper and oil will continue to be needed. Copper stocks are also currently at a 5-year lows indicating the upward price trend is unlikely to reverse in the near term.
- More opportunity exists for crude futures to correct upward than a downward copper trend when the commodities correct back to each other. While both are indicators foreshadowing larger scale movements in the global economy and other sectors, in the near term economic resurgence shows crude oil may be the undervalued commodity.
Copper has long been considered a leading indicator of global economic health. More than any other base metal, copper is tied closely to manufacturing, electrical engineering, industrial production, information technology, construction, and the medical sector. In general, rising copper prices have indicated strong industrial demand and global economic strength while lower prices have historically pointed towards a weaker economic period. Since copper can be considered a barometer of global economic health, it is no surprise a correlation to oil and gas demand exists as a healthy, growing economy requires more and more energy. The two commodities have closely tracked one another throughout history, and violent corrections often bring the trends back in line when divergences occur. Ever since oil prices were decimated in early 2020, there has been a dramatic divergence between the two commodity future prices. As global economies accelerate their exit from the global pandemic, the price of oil will be pressured to correct upward towards the price index of copper. This hypothesis is based on historic relationships and due to the fundamentals of supply and demand, financial structures, political issues, and price technicals.
The Copper Correlation
Historically, the price of copper has been strongly correlated with the price of gold, the Chinese economy, world trade, and most consistently, with the price of oil. There is a clear correlation with the price of oil because both commodities are affected by the same fundamental economic factors. The two prices are also intrinsically interwoven due to the energy costs related to copper mining and refining itself. Since energy costs comprise about 30% of the cost of copper extraction and up to 50% of the smelting and refining process, this is one additional factor that has caused the two commodities to move in near lockstep throughout history . Thus, long-term historical trends show as economic development shifts, the price of oil fluctuates alongside the price of copper.
Figure 1 shows the copper future price compared to the U.S. GDP. Although not perfectly correlated, major stalling or rebounding of domestic growth also resulted in large price swings for copper. The economic factors that correlate the price of copper and the price of crude oil are similarly related and fairly straightforward. Since copper is used in power generation and transmission, construction, factory equipment and electronics; copper has widespread applications in all sectors of the economy . As a result, copper has long been considered a leading indicator of global economic health. Indicators of a healthy economy often include growth, high employment, and price stability, all of which require energy consumption. Since three quarters of the globe’s energy is produced by hydrocarbons, the health of the economy is also closely tied to the price of crude oil. While the two commodities are closely related, it is not a 1:1 correlation and other factors have changed the relationship over the past decade and a half, particularly due to the U.S. shale boom and gains made in the renewable energy sector. The fact remains, industrial metals and energy sources are all economic signals, and their connection to each other is incredibly strong and sustaining.
Historically speaking, the correlation between the price of copper (cents per pound) and price of crude oil (dollars per barrel) is unmistakable. While divergences often occur, economic factors ultimately bring the trends back in line. The first major divergence seen in Figure 2 occurred during the mid-2000s as the price of copper quadrupled reflecting the extraordinary swell in demand by China . Urbanization, rural electrification, and growing car and appliance ownership resulted in flourishing consumption. A typical eight-story building uses around 20 tons of copper wire and pipes, and China built thousands of such blocks during the mid-2000s, along with 1500 new cars containing 50 lbs of copper each day . Millions of cell phones and computers were also sold in China, each containing ½ oz and 1.5 lbs of copper, respectively. Production struggled to keep up and inventories fell precipitously, triggering heavy speculative purchases. With supply and demand falling out of balance, the scales were tipped dramatically in 2006 when BHP closed Chile’s Escondida mine, the world’s top copper producing mine . The shutdown of a single mine shows how easily prices can soar if, or when, a supply disruption occurs. While the shutdown lasted just a few days, the supply disruption forced copper prices to be elevated for months before another boom allowed the gap between crude and copper to close.
Crude and copper prices steadily increased throughout 2007 and early 2008 as demand for PVC, the world’s third most used synthetic plastic created from hydrocarbons, and some metals like copper, neodymium and tantalum rose due to the increased growth of the countries of Brazil, Russia, India, and China . These areas, deemed to be developing countries at a similar stage of newly advanced economic development, had increased demand for electrical goods and were on their way to increased quality of life. Again, strong economic growth forced both copper and crude prices higher and culminated in a 2008 convergence before both commodities plummeted from the global economic slowdown. Later on as the U.S. shale boom caused crude prices to gain momentum, another violent correction was inevitable and when the government eased quantitative easing in 2014, crude oil prices corrected down to copper and have remained within range through 2020.
While some, including Darren Gaudreault, Admiral Metals Vice President of Purchasing, argue “there are economic drivers indicating the correlation between copper and oil prices may be weakening over time”, it is hard to argue with a 0.84 correlation factor from 2002-2019 [1,3]. These arguments are based on the fact that while global economic factors continue to connect the two, there are separate influences affecting each commodity’s value through supply and demand principles. While China accounts for roughly half of global copper demand, making its manufacturing sector a primary driver of prices, it was also the first to be hit with the global pandemic . Prices dipped in the short-term and many expected copper prices would fall further, but they did not. Copper prices recovered quickly while oil commodity prices tanked. This recent price divergence between copper and crude oil, two key economic development indicators for the world, leaves room for upward crude movement or a downward shift for copper.
Improved technology, increased use of alternative sources of energy, larger oil reserves, and a fluctuating Chinese economy are all factors that have led to a weakening relationship between oil and copper prices; but the connection has not been severed. It is easy to envision the two becoming less related as the years progress, but a long-term, full decoupling is difficult to imagine as they are still very much connected. The million-dollar question then becomes, which commodity must correct to the other? Luckily for oil professionals, it appears to be crude.
Since oil prices are influenced by four major factors that all appear to be bullish, an upward convergence towards copper seems probable. These four major factors for crude are further explained in the simple overviews below:
Fundamentals: Supply and demand has been imbalanced for months now, and as a result crude oil stocks have fallen back well within their five year range. With demand consistently outpacing supply since December 2020, prices will continue to climb until a balance is struck.
Financials: As discussed in The Intrinsic Value of Crude: An Underestimated Commodity, oil is incredibly undervalued when compared to everyday goods, the stock market, and commodities like gold and copper. The divergence between these benchmarks indicates oil is poised to rise until parity occurs.
Politics/Investments: The Biden administration is not focused on expanding domestic production and recent focus on ESG focused projects has shifted domestic fossil fuel development plans. As a result, U.S. production will continue to fall further throwing off supply and demand and supporting the upward price movement of crude oil. Globally, foreign countries, especially OPEC+, are regaining market share while recovering from the loss of revenue when oil prices were at decade lows. They will continue to benefit from upward price pressure in the near-term.
Technicals: Crude oil prices are quickly converging upon two massive, decade long structures while simultaneously approaching the tops of some key volume benches. These indicators and historic trends can be seen in Figure 3. As oil builds energy to overcome the current level of market resistance, all signs point to oil breaking free and rapidly rising until a new equilibrium is reached.
Since China accounts for over half the global demand for copper, there were initially concerns about how fast Chinese manufacturing would recover. With the global pandemic nearly in the rear view mirror for China, manufacturing and industrial production increased by 7.3% year-over-year in December 2020 . This is the most since March of 2019 and beat market expectations of a 6.9% rise as activity continued to recover from the COVID-19 shock . In fact, China is the only major economy on track to record positive economic growth in 2020 while other global economic powerhouses like the United States and Europe struggled with rising case numbers prompting governments to re-impose travel and business controls . Copper demand has been increasing in China and globally at the same time 5-year physical copper stock levels reached historic lows. Therefore, it does not appear copper will reverse its upward trajectory any time soon, so crude oil prices are likely to follow.
Copper is so essential in so many businesses, its price is widely seen as a proxy for industrial activity and economic vitality. Similarly, oil has long been the lifeblood of the modern economy by generating energy to make development possible. It makes sense both commodities will rise and fall in relation to economic activity and future outlook. Now, rebounding demand in China has pushed copper prices higher, but a surge of speculative buying means the market is vulnerable to a correction. It is always possible that copper prices could halt their upward trajectory, but is more of an opportunity for crude to correct upward and close the gap. While the correlation between the two has been strong in the past, the distant future holds a possibility that the old correlation may begin to break down and a divergence could occur. Although oil has been considered part of the old energy paradigm, it still has its place in the future of economic development. Copper, along with other precious metals, are essential to the new energy paradigm and the lifeblood behind renewables, but industrial work to mine and refine these commodities will continue to require crude’s energy. For the foreseeable future, copper and oil will continue to be a barometer for economic prosperity in developing nations and established societies. Identifying divergences between the two can potentially help foreshadow larger scale movements in the global economy and various sectors depending on which commodity appears ready for a correction. If the global energy transition does eventually break down this correlation, it will happen gradually as fossil fuels will continue to be viable until their eventual replacement with carbon-free energy sources. In the short term, economic resurgence shows crude oil may be the undervalued commodity relative to its cousin, which appears to be a leading indicator that crude oil prices are on the rise.