Gold is the most widely recognized safe-haven asset among investors. Therefore, during times of economic and geopolitical distress it generally tends to perform well, making it a leading indicator of fear.
Copper is the exact opposite. Because it is a key industrial metal that is used globally in a wide range of industrial applications, it performs strongly when the global economy is firing on all cylinders. This makes it a leading indicator of global economic health and has led to it being commonly called Dr Copper.
The copper to gold ratio is a valuable metric used to assess the relationship between the prices of copper and gold. It is calculated by dividing the current price of copper per ounce by the current price of gold per ounce. This ratio provides insights into the relative value of copper compared to gold at any given time. A higher copper to gold ratio indicates that copper is relatively more expensive than gold, suggesting increased industrial demand and a positive outlook for economic growth. This is often observed in strong and vibrant global economies where copper-driven industries thrive. Conversely, a lower copper to gold ratio may suggest a flight to safety and prevailing market caution. During such times, investors often seek the relative stability of gold, considering it a reliable asset in times of economic uncertainty.
A long-term price chart of the two reveals two things: First, Gold and Copper tend to move in the same direction a majority of the time. Second, it shows that the copper market tends to be more volatile and sensitive to price swings than gold. It makes sense that copper reacts to fundamental trends more quickly than gold. Copper is used explicitly for industrial consumption. More than two-thirds of the world’s red metal goes directly into building construction and electronics. The value of gold is much more likely to be shaped by interest rates and inflation expectations (rather than by noticeable swings in actual production and consumption) because most of of the gold in the world simply gets stored and transferred back and forth from one vault to the next.
Interestingly, the Copper to Gold Ratio correlates strongly with the 10-year US Treasury Bond Yield.
Higher interest rates may shift investor preferences away from gold towards income-generating investments such as bonds, causing the copper to gold ratio to rise.
When interest rates fall and assets such as bonds stop yielding returns, investors may seek alternative safe-haven assets like gold, causing the ratio to fall.
However, the copper to gold ratio is often regarded as a leading indicator for interest rates. When the ratio is rising, it suggests increased demand for copper, driven by higher economic growth. According to simple macroeconomic models, an increase in real gross domestic product will cause an increase in average interest rates in an economy.
The chart above displays the 1-year rolling correlation coefficient between the price of Copper and the price of Gold for a 1-year time window, commonly referred to as the rolling correlation. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the two metals moved in the same direction during the specified time window. Conversely, a correlation coefficient of -1 indicates that they moved in opposite directions. There are periods during which the prices did not change, which results in a standard deviation of zero and a correlation plus or minus infinity. These periods are removed from the data set and appear as gaps in the rolling correlation series.
Diversification is the practice of spreading investments across different asset classes to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.
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