China And Copper ETFs: Not The Relationship You Think

It is frequently said that copper is the industrial metal with a doctorate in forecasting economic trends – ence the moniker “Dr. Copper.” Conventional wisdom also states that Chinese demand is the primary driving force in the red metal's price action.

Investors might be surprised to learn otherwise. The iPath Bloomberg Copper Subindex Total Return Sub-Index ETN JJC is up 5.1 percent year-to-date, while the iShares FTSE/Xinhua China 25 Index (ETF) FXI, the largest China ETF trading in the United States, is down 1.6 percent. Sure, 2016 is not even four months old, but the year-to-date comparison of JJC and FXI underscores the point that copper and China are not as joined at the hip as investors have been led to believe.

Copper, China Myths

“The first myth is that copper and industrial metals are correlated to economic growth, especially China’s. Using year-over-year data since 1978, the correlation of copper to Chinese GDP growth is only 0.21, and is actually the lowest of all the industrial metals. The most correlated metal is zinc but the relationship is still weak at only 0.28,” said S&P Dow Jones Indices Global Head of Commodities Jodie Gunzberg in a recent note.

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In addition to zinc, aluminum and nickel are more correlated to Chinese economic activity than is copper. Interestingly, the S&P Dow Jones Indices research points out that industrial metals, including copper, sport inverse correlations to the U.S. dollar that are more intense than their positive correlations to China. Translation: It is good for JJC if the U.S. Dollar Index continues weakening.

“However, the weakening dollar helps metals more than any other commodity sector. In the past 10 years, for every 1 percent move down in the US dollar, gains in lead, nickel, copper, zinc and aluminum have been 7.2 percent, 6.1 percent, 5.3 percent, 4.6 percent and 2.2 percent, respectively. Also, silver has gained 6.0 percent and gold has gained 3.5 percent for every 1 percent slip in the dollar. The weak dollar helps far more than a strong one hurts,” added Gunzberg.

The research does not mention Chile, the world's largest copper-producing country, or the iShares MSCI Chile Inv. Mt. Idx. Fd(ETF) ECH so we'll fill in that blank here. ECH, the lone Chile ETF, is up 18.1 percent this year, or more than triple the returns offered by JJC. Over long holding periods, ECH's correlation to JJC is also modest.

That may not be surprising, as the Chile ETF allocates just 13.5 percent of its weight to materials stocks, making that merely the ETF's third-largest sector weight.