5-minute read
No it's not a new, horrible-tasting fizzy drink: "Doctor Copper" is the term used by investors and commodity traders for that orangey-pink base metal we find inside cables and in pipework.
In this article, we'll look at copper as a barometer of economic health, consider the relationship between the metal and the US dollar, and discuss whether UK businesses should be concerned about FX as well as the copper price.
Copper 1.01
Copper is a soft, malleable metal with high electrical and thermal conductivity. Humans have used the metal for thousands of years, originally to make tools and for jewellery and decoration, and later in architecture, construction, and electronics.
Today, around 60% of copper is used for electrical wire, 20% for roofing and plumbing, 15% in industrial machinery, and the remaining 5% goes into alloys. Chile and Peru mine around 40% of the global supply, with DR Congo, China and the USA also major exporters of the metal.
You can see the Doctor now
Due to copper's application in construction, transport, industrial uses, and many products, the price of copper futures can be used to assess and predict the overall health of the economy. Copper has historically been a strong indicator of recessions – check out the chart below showing the copper price overlayed with US recessions.
Rising copper prices imply strong demand and therefore economic prosperity. The opposite is true when prices fall, indicating declining demand and an economic slowdown.
Clearly, the barometer isn't infallible: as with any commodity, shortages or surpluses in the supply chain will affect the price and may not be linked to underlying demand or the health of the economy.
Copper and the dollar
As the global reserve currency, the dollar is the benchmark pricing currency for the majority of commodities, and copper is no exception. When the dollar falls in value, it follows that commodities cost more dollars to purchase, hence prices will rise.
The price of copper and the value of the dollar tend to exhibit an inverse relationship: the correlation is not perfect as dollar-specific or copper-specific events or shocks can lead to a positive correlation, but historically speaking the inverse relationship is a sound general rule.
What about UK firms with exposure to copper?
It makes sense that UK businesses with exposure to copper must consider the relative strength of the pound to the dollar in addition to the price of copper per dollar. But should they..?
Consider this very simple scenario: because of the mostly inverse relationship between copper and the dollar, when the dollar strengthens it costs more pounds to buy the same number of dollars, but fewer dollars to buy the same amount of copper... So there's no problem? Mmmmmm, not so fast...
As I mentioned earlier, the relationship between the dollar and copper is not perfectly inversely correlated. Times when the correlation breaks down often come against a backdrop of economic or market distress, which implies broader challenges are being faced by businesses.
Businesses faced with both commodity price risk and FX risk face a complex and potentially difficult challenge. An optimal strategy can be found by interrogating the underlying markets and working hard to understand the business's unique situation, objectives, and market.
Harry Mills, Founder & CEO Oku Markets
Problems arise when the relationship breaks down or when the pound v dollar exchange rate exhibits isolated volatility or trends (or both together). A recent example is after the 2016 EU referendum vote when sterling fell by about 17% against the dollar – this had nothing to do with dollar strength, and therefore no accompanying opposite movement in the price of copper came about – this will have been incredibly painful for UK firms trading in copper!
Should UK firms hedge GBPUSD exposure related to Copper?
Firstly, all decisions of whether to hedge or not are unique to each business, its objectives, and its market. If copper is a key component in your product, it's likely the price of copper will be the biggest factor to consider, rather than the price to buy dollars (to then buy copper) – because of the inverse relationship already discussed.
However, if you have an agreed price to buy or sell copper for future delivery, it makes sense to hedge the FX element too. Whilst copper exhibits approximately 4x the annualised volatility of the pound, the FX movement across even a short period can eat into margins considerably. And don't forget that hedging can mean a spot trade, a back-to-back forward contract, just as well it can mean to lock-in rates for forecasted future cash flows!
Need our help?
If you're unsure on whether to hedge or not, how much to hedge, and how far then you need to speak with us for an unbiased and transparent conversation.
We're proud to work transparently with our clients, and we work hard to break the asymmetry of knowledge and information in the FX market.
You can contact us for a review of your currency processes and for our guidance and suggestions at [email protected] or 0203 838 0250.
Thanks for reading 👋
