Strictly speaking, the prices of gold and copper have no fundamental relationship with each other. However, gold and copper tend to move in the same direction most of the time because they are positively correlated. And because of that, they make a wonderful indicator of how markets and especially interest rates are performing. More importantly, they are good indicators of what markets and rates are likely to do in the future.
The copper/gold ratio is an important key indicator measuring global economic health. The copper/gold ratio is calculated by dividing the market price of an ounce of copper by the market price of an ounce of gold. It is interesting to note that the copper/gold ratio is highly correlated (currently, the correlation is 0.85) and therefore a powerful coincidence indicator for 10-year US government bond yields. It is this directional tendency that holds the key to their intuition.
Gold is considered a safe haven for investors, a store of value. It is generally a less-used metal from an industrial perspective and most of its value is determined by interest rates and inflation expectations. A rise in the price of gold signals a contracting economy or a growing fear of a shrinking economy. So, during times of economic and geopolitical hardship, it generally tends to perform well, making it an important indicator of fear. On the other hand, gold prices tend to fall when the economy is doing well.
Copper is the exact opposite; it is a key industrial metal that is used almost entirely for industrial consumption, with more than 65% of it going directly to construction and electronics. As a result, it performs well when the global economy is booming making it an accurate barometer for measuring global economic expansion. Also, the copper market tends to be more volatile and sensitive to price swings.
10-year US government bond yields are important because they tend to rise during an economic expansion as investors’ inflation expectations rise and fall when the opposite scenario plays out. Therefore, the copper/gold price ratio should also tend to increase when the economy is expanding or contracting based on the state of the world economy.
Daniel Lacalle, chief economist and chief investment officer at TressisGestión, said he expects the copper-gold ratio to decline further as the economic recovery is already priced in. “Copper/Gold Ratio Rises Massively on Expectations of Rapid Growth”. “We feel the recovery bet is overblown”.
The latest dip in investor enthusiasm follows the Federal Reserve’s hawkish change of tone. The US central bank has signaled it will raise interest rates from historic lows. And this is prompting investors to review the positions of risk assets accumulated over the months in favor of gold.
