Copper/Gold Ratio Predicts Lower Stock Prices
Published June 17th, 2010 in Trading, Natural Resources Tags: copper, correlation, double dip, Dr.Copper, economic activity, gold, precious metals, ratio, recession.Earlier in the year we looked at an indicator that had a 95% correlation with the S&P 500 index. While at first it may seem bizarre, the indicator was simply the copper to gold ratio.
While the copper/gold ratio and the S&P 500 had enjoyed a remarkably parallel trajectory, one was beginning to outrun the other. Since then, this pattern has only continued. As you can see from the chart below, while the equity markets continued to make new highs, the copper gold ratio spent about 9 months going sideways (from August 2009 to April 2010).
Most recently, while the S&P 500 index managed to maintain itself above the February correction, the copper gold ratio fell significantly below it.
Click to see larger version of chart in a new tab:
There are several explanations. The first is that the relationship between the two is simply breaking down. I don’t think that is the case since the connection between the two is based on a tangential relationship. After all, copper is the most ubiquitous metal and is known as “Dr. Copper” for its ability to predict economic activity.
The other is that the relationship continues but one will eventually realign itself with the other. In that case, the lower price of copper is either signaling an upcoming economic contraction (with a decline in stock prices) or the other way around; that the copper gold ratio or copper (priced in gold) increases as economic activity continues and realigns itself with the higher stock prices.
Either way, I think we simply return to the battle royale between fundamental indicators and technical indicators.
copper, correlation, double dip, Dr.Copper, economic activity, gold, precious metals, ratio, recession
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Note that the flow of financial money into commodities has driven the price of copper to non-equilibrium levels. Production is quite strong, and stocks are building. You can’t say the same for gold since production is a small fraction of holdings.
I remember the early 80s. The same thing happened then. Industrial commodities went down, incl. oil. This was not a harbinger of a double dip recession but just a realignment of commodity prices to reasonable supply/demand levels. (Although the early 80s recession was even worse than the last one.)
Same flat behaviour (since June 2009) in 10-year yields. There may be some logic to this since there is some correlation between long-term interest rates and commodities.
So, Copper/Gold and 10-Yr T-Note yields are flat while the stock market makes new highs. Different markets saying different things.
Speaking of yields, this latest S&P 500 move from 1044 is a suckers’ rally. 2-yr going down to 0.7% and 10-yr going down as well. My friends, fixed income is not buying it!
This blog entry makes no reference to the period in which copper correlates to the S&P. Over the past decade, copper’s price behavior has closely correlated with equities. Historically (over much longer periods), it has not correlated closely enough to make it a useful indicator. Is Babak aware of this?
Based on your premise, I’m wondering about what you think about TCK/TCK.TO these days? Do you think investors should hold it as well as a strong staple stock, expecting them to function in a converse fashion?
Babak,
Isn’t gold doing its own thing, breaking all correlations anyway? So, any indicator with gold in it, probably has to be given less weight in analysis. As gold continues to rise, it will rise for no good logical reason as retail investors, momentum traders and techies pile on.
Regarding the market itself, did you check weekly NYSE Summation index at stockcharts.com The index is making lower lows and lower highs since Sept 09 and 50 week average is sloping down - which in the big picture sense is a big problem for bulls.
Please let me know your thoughts.
If we observe it a longer history, copper and stock correlation is not high. (ie from 97 to 00 and 07 to 08). Recently , deeper correlation of copper price to stock market is due to China tightening policy where China is a the biggest copper-comsuming country.