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Copper/Gold Ratio As Predictor For S&P 500 at Trader’s Narrative





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On Wall Street copper is give the title of “Dr. Copper” because of its ability to predict future economic activity. When the price of copper falls relative to its prior annual price, we usually head into a recession. But we can’t look at copper priced in dollars - they are useless after all, aren’t they? - instead let’s look at copper in terms of ‘real money’. Gold.

It turns out that copper priced relative to gold is actually very correlated to the equity markets. And not only correlated, it tends to predict a few months ahead of time where the stock market is headed.

Take a look at the chart which David Rosenberg shared in his recent market commentary. It originally comes from FT’s short view column (and video). You can click the chart to get a larger version:

copper relative to gold compared to S&P500 index
Source: Gluskin Sheff

I don’t think that is a result of data mining. Copper is used in almost every single part of global industry and gold is a barometer of monetary and systematic risk. So put the two together and you have a single indicator that reflects economic activity. According to Gluskin Sheff the copper/gold ratio has a 95% correlation with the S&P 500.

Needless to say, the hard right edge of the chart doesn’t look all that healthy right now.

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23 Responses to “Copper/Gold Ratio As Predictor For S&P 500”  

  1. 1 bill

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    straight forward, simple and clear…i like

  2. 2 Elizabeth

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    I like too–thanks for this–very helpful.

  3. 3 Jim

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    But it only goes back to 2007. What did it look like for a long time before that?

  4. 4 Mike

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    To answer Jim’s question, perhaps David did not include data prior to 2007 because it didn’t support his thesis?

    The following chart plots Copper:Gold ratio against SPX but also includes my preferred indicators - construction and a custom Cement producers index. Think about it… what gets put down first in any construction project? Cement, lots of it. (and rebar but…)

    The only problem with the cement index is there are not that many public cement companies of note; I’m reviewing some of the emerging markets tickers but many - perhaps all - of them are not well traded. I plot LaFarge seperatly as the symbol doesn’t have much history.

    The chart also has a custom index of a few global construction integrators - like Fluor, SNC Lavalin and such.

    If the “CIX” Cement Index or the easier to get DJ Global Construction Index has any forecasting ability, markets aren’t looking very healthy here.

  5. 5 Babak

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    Mike, I doubt that Rosenberg is trying to pull a fast one (or FT for that matter, this is originally their idea remember). These sort of indicators have a tendency to work for a set period of time and then fall out of sorts - almost all indicators do this. Your work on the cement idea is very interesting. Thanks for sharing.

  6. 6 Bucky

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    How is copper/gold ratio calculated?

  7. 7 Babak

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    Bucky, I assume by taking the daily futures close for the two commodities.

  8. 8 wayne

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    Cash prices for most commodities with available historical data link

  9. 9 Bucky

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    Thanks for that link Wayne. Anybody got a link where I could get the historical data in one spot, rather than having to clink a link for each day, find the quote, and write it down?

    My broker doesn’t supply commodities data otherwise I could download it there.

  10. 10 Bucky

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    can’t find that data on yahoo finance either unfortunately.

  11. 11 wayne

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    Norma’s data

    About $10-$15 per commodity, cash or future

    http://normashistoricaldata.com/

  12. 12 Bob Kudla

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    You can use the equity proxies of jjc and GLD

  13. 13 Babak

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    Bob, that’s a creative way of doing it. But I’m not familiar with JJC - does it actually track copper accurately? ETFs can be notorious for valuation drift.

  14. 14 Arthur Hall

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    How aboiut using a crystal ball ? Gypsy fortune teller ? Palm reader? Taro cards ? I firmly believe all of these so called indicators are attributed to the predictor’s imagination, and what he hopes will come true. My internet serves me up with all kinds of make a million ideas. If they are so good why do they get given away for nothing or next to it? Arthur

  15. 15 Michael

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    Beautiful Arthur. 85% of investors lose money in the stock market (including most of the above commentaters I would guess). 75% of all mutual funds lose money. Too many people getting caught up in all the minusha and not understanding that the market is not technically driven. It is emotionally driven. Forget your charts and all the weird angles and try “betting” with your gut. You might just make some money for a change.

  16. 16 Frederick Clements

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    It’s amazing. While there’s a ton a technical indicators, everyone is always looking for the golden bb that’s simple and will indicate where the market is headed. Invariably Mr. Market always wins and proves try as you may you can’t predict the market.

  17. 17 Mike

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    Babak - Like you I doubt Rosenberg was trying to pull a fast one, but supporting the notion without including the longer term view displays a certain lack of rigour that I would expect someone like David to exhibit.

    There’s nothing wrong with the notion of looking for leading indicators but it seems to me that using copper right now isn’t going to be terribly useful given that *everything* got bid up real big over the past year and many sectors and commodities would appear to have run up beyond where they should be, unless one really believes that we are going to see a V-shaped recovery.

    I sure don’t… but then again I let price decide for me when to get in and out and use my opinions about the macro side more as a backdrop where I measure risk (in either direction).

    At any rate the real call on copper and all commodities was the USD reversal in late 2009, which few got right.

  18. 18 Michael

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    Mike…. surely you jest. The USD reversal in 2009 that few got right. Hmmm seems to me a lot of people got that one right. Myself included. Exactly the point of not chasing after every herringbone and for once following your gut. Pretty easy to see the USD reversal with the incredible amount of debt that has been put on this countries future generations. America whether you choose to admit it or not is a 3rd world country. King Dollar will go to zero. The only “real” money that exists is what has throughout history been the only one to exist and that is hard commodities. There will soon come a time that the only way you can buy something is to exchange it for something else. Once the banks “short” manipulation of gold and silver ends you will see gold soar to at least 5k per ounce with silver not far behind, and I’m not even a gold bug. Get ready the world you live in is about to change……drastically.

  19. 19 Mike

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    I am not talking about the move down, I’m talking about the reversal UP late in 2009. Late in November 09 I was pounding the table trying to get attention to the drop and pop setup; by the end of the first week of December the up trend in the Euro was being tested.

    The problem with focussing only on the U.S. woes is that one can fail to recognize just how flawed other regions are; back in November was talk of the break up of the E.U. an every day affair in the media? No, but it is now. Perhaps that’s a passing fad but it does serve to underscore a strategic (as opposed to tactical) weakness Euroland has — they will never be able to conduct monetary or fiscal policy in as coordinated a way as the U.S. or China or Russia or Canada or Australia or even the U.K. Indeed, the U.K. has many of the same issues the U.S. faces and there are hardly any guarantees that the situation in the U.K. and Europe will not start to weaken; one can expect they will turn on the debt spigots again too.

    As for Gold, lets just say I’m not a true believer, for a couple of reasons. One is distribution - there isn’t enough of it in enough hands to make for liquid markets and illiquid markets on a global scale probably mean civil wars all over the globe as we revert to the mean form of mean. Thus guns, water, food and fuel will be important and I bet gold will play very little part in that happy outcome. For that reason I doubt all that will come to pass. We’ll muddle through.

    Secondly, I’m not a believer in big Gold forecasts much for the same reason that I don’t believe in big long term forecasts for almost anything. The right price is what people will pay for something in the foreseeable future.

    There is no macro view I can live with that supports gold going to the moon and staying there. If it goes to the moon it will be important to know when to step off the elevator before it crashes back down again.

    That all said, if Au is going to the old highs and beyond, I’ll get my chunk of it and if the worst outcomes visit us I feel confident that I can turn whatever paper gains I get along the way into something more tangible.

    Until or unless that all transpires, it’s business as usual. I happily take the long and short side of any trade, including and perhaps especially gold. What’s most important is to know when to fold em and that is something most gold investors seem to forget. It’s never “different this time”.

    I made a decent return shorting miners in December and again in mid January (where I dumped all my longer term energy holdings, expecting and getting much lower prices). I’ve not bothered to go long this latest bounce in the yeller metal for a couple of reasons:

    1) Despite the movement in Gold, the dollar has not retraced at all, it is merely going sideways

    2) The E.U. still has plenty of event risk hanging over it. If Greece, Ireland, Spain, et al all legitimately disappear as worries, then the USD might indeed fly again

    3) I’m concerned about what China is doing and given the potential for market and currency moving upsets coming out of there (i.e. a currency revaluation), until the USD index basket starts to move again, there’s no rush to put real money at risk in something so dollar correlated; instead I’ve been purposely trading things that are not so dollar tied (Nat gas for one, but also Canadian banks long, until closing those bounce gains yesterday).

    As for (1) it could be that Gold is truly on it’s way up and big time, having disassociated it’s link with the USD (and perhaps any paper currency). That would tie neatly in with your scenario.

    But let’s not put the cart before the horse. Such a disentanglement of Gold from the USD would not happen in a mere handful of days.

    What has more likely happened is that gold buyers, having seen it pushed down ruthlessly from a parabolic (but perhaps not *the* parabolic) spike, decided it was cheap enough to buy regardless of the USD direction and the euro-USD cross price extension lower on Feb 5 “appeared” like it might be a bottom then, particularly when matched with price action the very next day. That alone would be reason enough to give gold *traders* a reason to believe that the USD rise might have halted and be ready to reverse.

    That is in my books “premature”. A reversal has not taken place - all that can be said about the EURUSD is it is in the middle of the second week of a two week pause in the downtrend. Unless we start to see higher swing highs and lows on the daily charts, this downtrend remains in place.

    Likewise, Sterling is building a bear flag on the weekly chart, just below a breakout (down) through a 9 month period of consolidation. Unless economic news supports GBPUSD rising and soon, that bear flag is more likely than not to resolve as normal - down - and initiate a significant leg down in Sterling.

    Should Sterling and euro drop further in the near term I think we’ll see Gold break support near 1074 fairly rapidly and a failure to hold the Feb lows could easily see Gold push to 925 or lower in short order.

    So, there are a few “IFs” that have to come to pass before all that happens, and likewise we can construct the upside scenario too. For me I’ll be content to trade gold on the long side only if a push down comes to pass soon AND then price can climb above that - once that occurs and we see what currency markets we’ll know if the coast is clear or not.

    Cheers

  20. 20 Jay

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    Nadeem Wayalat of the Market Oracle called the US dollar bounce with a target of 84 on the US dollar index

  21. 21 David

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    Michael, Way to long winded.The dollar index in nov.2009 was 75.The spot gold price was 1120.Feb.18 2010 the dollar index was 80,gold was 1120.Are you sure the dollar has reversed and gotten stronger compared to gold.It looks like gold is doing what it always does …its a revealer that it takes more fiat currency to maintain its value when compared to gold.David Rosenberg wasn’t that easy to understand and quite quantifiable!!!!

  22. 22 Mike

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    David, try this shorter response on for size:

    Rosenberg wrote an article on the predictive value of the Copper:Gold ratio as it applies to equity markets.

    What does the value of the dollar against gold have to do with that? Equity markets can rise or fall in a falling or rising USD environment as has clearly been demonstrated many times during this decade.

    Call me a heretic if you will, but the value of gold is entirely arbitrary, not unlike the value of a fiat currency. It is worth exactly what anyone is willing to pay for it at any given time. What I can I guarantee you is that a great many gold holders will not know when it is time to leave the party.

    The more I hear about China and pension funds being bullish on commodities the closer we are likely to that time.

  23. 23 mico

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    Cement as well a silver lead sp500. The best way to look at it is on the short term wings. Both work on short term swings. Longer term Cement works. I use silver on the swing and it has worked. Things can change though

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