How this chart is a huge warning for the markets

How this chart is a huge warning for the markets

Many on Wall Street use one indicator to predict the market. It's something so common, a little bit of it is probably in your pocket right now. No, it's not money specifically but the very stuff that literally goes into making money (albeit less and less every few years).

We're talking, of course, about copper.

It's a cheap metal relative to gold or silver but it's integral to manufacturing and construction. When either or both of those are up, the demand for copper goes along with it. It's said that copper tells so much about the health of the economy that the base metal is sometimes referred to Dr. Copper.

But so far in 2013, copper hasn't been feeling so well itself. Meanwhile, the markets are having a great year. Copper has lost 11% year-to-date, while the Dow Jones Industrial Average is up 15%.

Looking at the correlations between the Dow and copper prices over the past decade shows an interesting relationship. Over the past ten years, the copper and the Dow have had a correlation coefficient of 0.61.

Without going into the math behind how that's figured out, here's what it means: When two things have a positive correlation, their prices move either up or down together. The closer the correlation coefficient is to 1.0, the stronger the relationship between the two. Likewise, when two things have a negative correlation with each other, they generally move in the opposite direction.

Copper and the Dow have usually moved together in any given year – except this one.

Year Copper & the Dow


2013 (Jan –Sep) -0.81
2012 0.46
2011 0.47
2010 0.89
2009 0.91
2008 0.92
2007 0.71
2006 0.25
2005 0.34
2004 0.12
2003 0.80

For the first three quarters of 2013, copper and the Dow have had a negative relationship as reflected in their correlation coefficient of -0.81. During the five years prior to this one, the correlation coefficient was 0.83, indicating a fairly strong relationship.

Case closed, right?

Not exactly. While the correlation between the two in any given year has been positive over the past decade, the relationship fluctuates during the course of the year.

Below is a chart looking at how a one-year correlation between copper and the Dow changes. For example, the correlation between the two from February 16, 2009, to February 16, 2010, was 0.98. During that entire 1-year span, the two moved nearly perfectly together.

On the other hand, from April 12, 2006 to April 12, 2007, the two had a correlation coefficient of -0.73. Over that one year period, copper and the Dow generally moved in opposite directions.

Big drops in correlation occurred half a decade ago. In early 2007, copper prices dropped as stocks were rising. In late 2008, the two moved down together during the financial markets collapse, which is why they had a correlation coefficient of 0.96 in the beginning of 2009.

To be sure, copper – like all things – has its own supply and demand issues not related to the general economy. But, it's interesting to note the divergence between the Dow and copper starting at the end of 2012.

That's around the time the Federal Reserve Bank increased the amount of its "quantitative easing" ("QE") program to $85 billion. Under this policy, the Fed has been buying US Treasury and mortgage bonds to add dollars into the financial system while rasing bond prices. Higher bond prices, in turn, has reduced interest rates (and the borrowing costs for investing in, say, stocks) but the Fed remains committed to QE so long as it feels the economy needs the stimulus.

Gina Sanchez, founder of Chantico Global, believes copper is saying a lot to the world. And it's giving it a loud and clear warning.

"Dr. Copper has always been a great economic indicator," says Sanchez to Talking Numbers. "I think what it has been telling us for the last year is that in the midst of all this stimulus, maybe this economy isn't quite as healthy as the [stock market] would suggest."

"I would say Dr. Copper is giving us a pretty healthy warning right now that there could may be some weakness in the economy that we're not baking into the stock market," Sanchez says.

Looking at the technicals, Belpointe managing director Jeff Tomasulo agrees with Sanchez on how important the relationship is between the copper and the Dow.

"If you look at the long-term chart of copper, you see exactly what [Sanchez] is talking about," says Tomasulo. "What a great correlation that copper and the Dow has had."

Tomasulo believes there's a trade to be had in playing the Dow versus copper. But, he also says weak copper prices are related to the weak dollar policy of quantitative easing.

Want more of what this fascinating indicator may mean? Watch the video above to fundamental and technicals analyses from Sanchez and Tomasulo.

More from Talking Numbers:
These are the most hated stocks on Wall Street

Buffett: Government showing 'extreme idiocy'

Lebenthal: What a government shutdown means for municipal bonds

Follow us on Twitter: @CNBCNumbers
Like us on Facebook: