Commodities have been stumbling badly.

 

To get a sense of how badly, take a look at the Greenhaven Continuous Commodity ETF (NYSE: GCC), a diversified exchange-traded fund that uses futures contracts to provide exposure to 17 commodities like wheat, gold, oil and others. Since peaking at the end of April, GCC has fallen about 20%.

That’s bear territory, and it might be cause for concern. Sharply falling commodities suggest demand for raw materials is weakening and the global economy is headed for a recession, possibly dragging down the U.S. economy along with it.

 

#-ad_banner-#Plunging oil prices in particular have typically been one of the more reliable signs of a looming recession, but maybe not anymore. Normally, the nearly 60% price drop we’ve seen in the past six months would be a major red flag. But because the U.S. fracking boom has vastly increased global oil supplies in a relatively short time, it’s tough to say how much of the decline is demand-related.

 

So to get a better idea of the state of the economy, investors might want to look instead to copper.

 

Copper is tremendously versatile, with applications in many industries including consumer electronics, residential and commercial real estate, medicine, agriculture and aerospace, to name a few. Such pervasiveness is precisely what makes demand for the metal such a good measure of economic activity and why so many investors rely on “Dr. Copper” to help diagnose the health of the economy.

 

So what’s the story with copper now?

 

Like many commodities, it has taken a severe beating. The current spot price, $2.57 per pound is nearly 45% below the 2011 high of about $4.50. In just the early days of 2015, the red metal has fallen more than 10%. That’s a big move in commodities markets.

 

Probably the biggest drag on copper right now is slowing demand from China, the world’s top user of the red metal with 40%-to-45% of total global consumption. Although still expanding at faster rate than other economies, China’s economy is beginning to cool, prompting analysts to estimate that China’s copper requirements will only rise by about 5% this year, down from 7% in 2014.

 

Such estimates incorporate factors like a downshift in manufacturing activity, as measured by China’s Purchasing Managers Index. A PMI greater than 50 indicates general expansion of manufacturing activity, while a below-50 reading suggests a general decline. The current reading, 50.1, is a one-year low and well under the decade peak of 63 achieved in 2005.

 

China’s real estate market, in a major slump since May 2014, is weighing on copper, too. Simply put, lower property demand reduces the need for copper, which is used to make pipes, wiring, roofing materials and other building construction elements.

 

The real estate slump is expected to persist throughout 2015, with analysts projecting as much as a 30% decline in Chinese housing prices by year end. Also in the mix: China stockpiles copper and may be working off excess inventory levels, so actual demand may be even lower than current economic activity suggests.

 

Remove China from the equation, and the copper situation looks even worse. For instance, non-China demand for refined copper has actually fallen 7% since 2003, according to Morningstar. (Copper is considered refined when it’s purified enough for industrial use, as opposed to crude copper, which is high in impurities.) Economic weakness in Europe, Japan and a number of emerging markets is the main reason for shrinking copper requirements outside of China.

 

While lower demand is copper’s biggest problem right now, the metal does have an oversupply issue, though nothing like the oil glut. It’s because many mining firms are ramping up production to grab market share. Industry analysts expect to see a modest, but protracted, copper surplus.

                                                                                        

Consider, for example, the latest forecast from the International Copper Study Group (ICSG), a global forum for governments and copper industry participants founded in 1992. The ICSG expects refined copper production of 23.1 million tons in 2015 — roughly 390,000 tons, or 2%, more than projected usage. Analysts at the French bank and financial services firm BNP Paribas SA (OTC: BNPQY) foresee this sort of modest surplus for the next couple of years because of the “mini-boom” in copper mining.

 

Since commodities in general move in the opposite direction of the dollar, the strong greenback is yet another headwind for copper. Looking ahead, dollar strength should persist because of worsening economic and geopolitical situations abroad, progressive improvement in the domestic economy and an increasingly risky investment picture that is likely to attract investors around the world to U.S. Treasuries and other safer dollar-denominated assets.

 

In light of all the obstacles facing copper, industry sentiment about the red metal is understandably grim. In its annual gold, silver and copper report for 2015, professional services firm PricewaterhouseCoopers, LLC revealed that 60% of the copper producers it surveyed expect the price of copper to fall during the next 12 months.

 

Risks To Consider: All signs currently point to more weakness in copper. Copper investors that now think it’s a good value might be making the classic mistake of trying to catch a falling knife.

 

Action To Take –> Despite an already precipitous drop, copper probably hasn’t bottomed yet and still carries significant downside potential, perhaps even a risk of double-digit losses this year. Thus, it’s an investment better avoided until the demand and supply equation comes back into balance. Also consider that persistently weak copper prices might portend a recession, an event that could have serious repercussions for stocks and other riskier types of assets.

 

If oil, natural resources or commodities are what interests you, then look no further than StreetAuthority’s Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade’s experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. To gain access to Dave’s latest research, click here.