Commodities Corner: Copper, coal: crystal balls for the global economy

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SAN FRANCISCO (MarketWatch) ?€" Copper, coal and other industrial commodities can be great tools for predicting economic prospects and right now they?€™re offering a gloomy outlook, but a closer analysis shows a glimmer of hope as the world struggles to avoid recession.

?€œPeople are looking at commodities and trying to figure out if a slight adjustment in the price of oil, copper, aluminum, etc. means that the world will prosper,?€ or the global economy will fall off a cliff, said Byron King, editor of investment newsletter Outstanding Investments.

Sharp global selloff after Fed announces stimulus

Markets throughout the world experienced sharp declines following the selloff in the U.S. in reaction to the Federal Reserve's stimulus move. The Fed announced a shift to long-term government bonds, known as 'The Twist.' Photo: REUTERS/Yuriko Nakao

But while some commodities can be leading indicators, making their moves ahead of the broader market, others may only offer a ?€œcoincident?€ indicator for the economy ?€" one that by definition shows the current state of the economy, analysts said.

Copper has been widely seen as a leading economic indicator among commodities ?€" so much so that it?€™s referred to as ?€œDr. Copper,?€ suggesting it holds a Ph.D. in economics due to its ability to help predict economic trends. But analysts may also look to coal, zinc, iron ore, lead, aluminum, tungsten and oil for hints on what direction the economy will take next. Read more about copper.

Right now, none of those commodities appear to be offering any good news, especially after they dropped in tandem with the broad global equity market selloff on Thursday.

Year to date, futures prices for copper /quotes/zigman/635638 HG1Z -4.89% have fallen by 21% on the Comex division of the New York Mercantile Exchange.

Coal futures /quotes/zigman/1886034 QL1Z 0.00% have also lost about 5.6% year to date on Nymex. On the London Metal Exchange year to date, cash prices for aluminum are down 6.6%, lead has declined by 11.6% and zinc has lost over 14.5%, according to data from FactSet Research.

?€œCopper is saying that the global economy is rapidly slowing and the risk of a recession has increased,?€ said Sam Subramanian, editor of AlphaProfit Mutual Fund and ETF Newsletters.

Digging deeper

But the sharp declines in commodities don?€™t set the fate of the economy ?€" and the moves in commodities can offer a deeper, more telling story of what?€™s to come.

The earlier in the production cycle a commodity is needed, the more likely it is to be a leading indicator, said Philip Romero, a finance professor at the University of Oregon and former chief economist of California.

/quotes/zigman/635638 HG1Z 3.32, -0.17, -4.89%
/quotes/zigman/3870025 SPX 1,136.43, +6.87, +0.61%

Dec. copper vs. S&P 500 Index

Copper, for example, is used in wire telecommunications, which must be done before a building, like a factory, can be occupied, he said. ?€œTherefore, copper should ?€˜lead?€™ manufacturing output by six to 12 months.?€

However, ?€œmost materials and energy inputs are coincident indicators,?€ he said. ?€œThey don?€™t need to be bought until the goods that use them are produced.?€

Gold, on the other hand, plays another role. It?€™s a ?€œmainly an inflation hedge,?€ said Romero. Read a blog on gold as an economic indicator.

For hints on the state of economic health, Romero said he would place his reliance on materials used in building industrial facilities, such as lumber, concrete and copper. ?€œThe lead time is quite long, and most factories aren?€™t built unless demand for their products is reasonably assured.?€

Even analysts who aren?€™t completely convinced of the ability of commodities to predict an economic path believe they play an important role nonetheless.

Kevin Mahn, president and chief investment officer at Hennion & Walsh Asset Management, said that while commodities may not necessarily say a lot about the health of the economy, they can certainly ?€œprovide insights into demographic trends as well as the state of the economy in terms of areas of growth and development.?€

In terms of potential areas of growth and development, industrial commodities can be used to ?€œgauge infrastructure development projects across the globe,?€ he said. And when it comes to demographics, as the world population grows, particularly in emerging markets, demand for agricultural commodities increases.

Corn /quotes/zigman/1741627 C1Z -1.42% and rough rice futures /quotes/zigman/1785034 RR1X -1.23% traded on the Chicago Board of Trade are among the few commodities that have gained year to date. Corn has climbed 3% and rough rice has added 19%.