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Copper vs Gold - A Macro Microcosm

UPDATED (23-April-2020): What a difference 8 months can make. Back in August last year I correctly highlighted how and why fortunes could turn for the copper/gold ratio (and its macro-companion market, the US 10-year treasury yield). You can check that piece out below, but for now here's a quick update on the outlook for the copper/gold ratio.

Much like treasury yields, the copper/gold ratio broke to new lows through the corona crash. As a refresher, copper/gold finds its macro bearings from copper being sensitive to the economic cycle (particularly with regards to China), and gold being sensitive to swings in risk sentiment. So as a macro indicator, it's definitely worth keeping track of.

copper/gold vs US 10 year treasury yields chart

Much like US 10-year treasury yields, the copper/gold ratio has resisted making new lows; instead opting for a period of consolidation. Equities have taken a similar path in that they've refused to probe the lows, but have opted for a more forward-looking stance.

Here's where I would note one particular thing to watch out for: if copper/gold (and US 10yr yields) do break down to new lows, that should be a major macro warning sign for equities.

That's not my base case. But if pressed, I would say it's entirely possible *if* the news cycle sours and pushes back against the wall of stimulus (I could give an endless list of possible dark news stories that could trigger a risk-off round, so I don't necessarily want to be too cavalier about it either).

My base case is that we've seen the low point on the chart above. In the battle of stimulus vs social distancing, stimulus is definitely casting a long shadow, and while many would point out the downside risks, I think in the current incarnation the market has got its head around the pandemic impact and prospective future path.

But back to the charts, the relative speculative futures positioning indicator for copper/gold shows a slight tick up and a higher low against the lower low in copper/gold (a classic bullish divergence signal). Add that to the fact that it's basically a crowded consensus trade, the wall of stimulus, and the potential for 2-way risk (could the impact be briefer/less than expected? vs longer/worse than expected?) ...I'm tempted to once again call for a bottom here.

While I was right last time, that was an entirely different situation to now (read: easier!), and of course in the end my "right" call ended up wrong as the facts changed. Whether I'm right or wrong this time, I would say it's definitely a set of charts worth pondering and monitoring...


Callum Thomas

Head of Research

Topdown Charts


ORIGINAL POST (21 Aug 2019): Last week I outlined some of the extreme moves in bond yields, and this week I'm taking a quick look at one of the bond market's close traveling companions; the copper to gold ratio.

It's an interesting indicator to track for a few reasons, but the basic intuition or reason for tracking it is that copper tends to respond to swings in global growth and gold tends to respond to swings in risk appetite. Thus a situation where growth slows and risk appetite turns sour should see the copper to gold ratio collapse.

And that's exactly what we've been seeing lately.

Indeed, some of you will recall some form of the below chart which was wheeled out when bond yields were rising as a reason for yields to keep rising, and then when the ratio rolled over as a harbinger of lower yields. It makes a degree of economic sense given bond yields tend to respond to growth and risk appetite in the same manner as well.

copper to gold ratio and the US 10-year treasury yield chart

So if we (or at least me) think that bond yields look overdone, is the collapse in the copper to gold ratio also overdone?

It's an important question, and its answer will depend in large part on whether the global economic cycle is at its end ...or about to extend. If the global policy pivot by central banks can help avert a recession then one of the first places that we will be able to see it will be in the copper to gold ratio (as it turns back up).

But at the same time, these are markets, and changes in risk appetite and growth expectations are just as much about swings in sentiment as they are about reality.

Perhaps the best way to show this, and probably a good indicator to track for making judgements about the future path of the copper to gold ratio, is the spread in speculative futures positioning for copper vs gold. The chart below shows the copper to gold ratio against this relative futures positioning indicator, and perhaps unsurprisingly it has fallen to an extreme low.

copper vs gold ratio and relative futures positioning indicator

That is, speculative futures positioning in copper is at multi-year lows, and for gold it's at multi-year highs. Typically with sentiment indicators like this you want to pay attention when they reach an extreme. Going solely off this chart you would say that the red line is giving a contrarian bullish signal for copper vs gold. So it's fair to say that objectively the odds of a rebound in copper vs gold are decent at this point.

But it's often dangerous or at least sub-optimal to look only at one chart or one indicator, so let's take a quick look at a couple of key drivers/macro factors for each side of the ratio.

First, copper tends to travel relatively closely with the China 10-year government bond yield. This makes sense given China accounts for over 50% of world copper demand. It's no secret that China's economy has been slowing, and hence it makes sense to see copper weaker in this context.

Second, gold tends to travel relatively closely with US real yields. This makes sense from the point of view that the opportunity cost of holding gold is much lower when cash is yielding negative returns in real terms (if anything it makes holding gold seem like a good idea).

Copper and gold price drivers

So while there is definitely a sentiment component, you're basically left asking "what's going to happen to US real yields and Chinese government bond yields?"

...and that basically makes what seemed like a simple problem into a more complex beast.

To simplify - perhaps even over-simplify - I think the biggest driver and what it will mostly come down to is what happens with China.

Faced with the trade war, global growth slowdown, previous policy tightening, and structural headwinds, China has seen a cyclical slowdown, and to date it has only introduced piecemeal stimulus measures as it seeks to avoid the same kind of indiscriminate credit surge wholesale stimulus packages of the past.

China PMI vs copper price chart

So in the end we're left wondering when/will China step up stimulus? When will the trade war end? (and) When will the global economy shake off its current malaise?

Leaving aside the sentiment aspect, at the very least we can say it's worth keeping a close eye on the copper to gold ratio as it will be one of the first things to move when (if) the global economy picks up again. So make sure it's in your global chart monitors!

But to offer some final thoughts on the outlook, in my view we are either at or near a bottom in the copper to gold ratio. This is based on the contrarian bullish signal in positioning, the overbought and overvalued signals in treasuries (if treasuries are overdone then arguably this is also overdone), and a constructive outlook for the global economy. As I mentioned in my just published Monthly Chartbook, my base case is that we are in a global slowdown and that it's more likely that we see the economic cycle extend vs end.

Any comments/questions on this just get in touch direct or by social media.


Callum Thomas

Head of Research at Topdown Charts Limited

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