Why investors go to copper as an inflation hedge

Story by Jeff Desjardins

Every year, a vast amount of copper is used by the global economy to manufacture a wide variety of goods.

It's a major ingredient in big-ticket consumer goods like autos, appliances, electronics, and new homes. Simultaneously, copper is also gobbled up for many industrial uses including telecommunications, utilities, construction, and industrial machinery.

An economic bellwether

Today's infographic comes to us from Kutcho Copper, and it shows the red metal's important role in the economy, as well as why it has become a famous economic bellwether.

Rising demandWhen the economy is doing well and new things are being made, demand soars for the red metal.

Rising priceWhen demand goes up, it drives the price of copper higher.

All eyes on copperBecause of this historic relationship, analysts around the world watch the price of copper closely.

Dr. CopperCopper's long history of predicting economic movements has famously earned it a nickname as the metal "with a Ph.D. in economics"

In other words: when construction and manufacturing are growing, so do sales of copper products. But this link as an economic gauge has other important implications, especially to investors looking to build a robust portfolio.

Rising prices, rising copper

While copper's link to economic trends is interesting, it's power to shield a portfolio from inflation is even more compelling.

Rising prices come from an overheating economy with strong consumer spending - the same factor that is an influence on copper prices. As a result of this connection, tor every 1% annual increase in consumer prices since 1992, copper's price jumped almost 18%.

In an analysis by Bloomberg Intelligence, copper outperformed every major asset class aside from energy as an inflation hedge - and during periods of rising consumer prices, copper had triple the 5.2% gain logged by gold.

A threat to portfolios

Inflation can absolutely kill an unprotected portfolio.

Why? If inflation is higher than the portfolio's rate of return, then that portfolio is actually producing a negative real return. (Example: 2% growth - 3% inflation = -1% return)

In other words, inflation can be a "stealth" threat that chips away at returns, especially for fixed income portfolios. The good news: holding copper or other commodities can protect against rising prices.

Copper: the inflation hedge

At the end of the day, other industrial metals are very specialized in their use, and precious metals tend to be driven by investor sentiment.

Copper, on the other hand, is used in a vast array of industrial and technological uses, which makes it a proxy for the economy as a whole.

"Copper is more sensitive to inflation and the dollar because of its uses and its growth with the economy."

- Jodie Gunzberg, S&P Dow Jones Indices