Copper is a cyclically sensitive metal that was given the moniker of Dr. Copper, because it is said to have a Ph.D. in economics because of its ability to forecast global economic trends. Its recent breakout from a 10-month base excited a lot of people. Similarly, the turnaround in the relative performance of materials stocks was interpreted as a cyclical green shoot.
On the other hand, the sideways pattern of the copper/gold ratio gave a different message of economic stagnation. Both copper and gold are metals with inflation hedge properties, but copper is more cyclically sensitive. The copper/gold ratio acts as a cyclical indicator to filter out the inflation sensitivity of changes in metal prices.
Therein lies the mystery. Are the markets signaling a cyclical rebound, or not?
A cyclical mystery
Investors are faced with a cyclical mystery. Commodity prices, which are cyclically sensitive, have been rallying. Equal-weighted commodity prices have been on a tear, led by the agricultural commodities (thank you, cocoa).
An analysis of the relative performance of materials stocks yields some clues on the source of the strengths and weaknesses. It’s the chemical stocks that are the leaders in this sector. By contrast, the steel and mining stocks are weak.
Further analysis of the relative performance of cyclical industries shows that most are in relative uptrends, with the exceptions of metals and mining and transportation. In other words, the message of the market is mostly telling the story of a cyclical recovery.
A golden puzzle
This begs the question: why is the copper/gold ratio trading sideways? Mathematically, it’s because both copper and gold prices have been strong. But if copper is strong for cyclical reasons, what is driving gold prices?
I recently highlighted the bullish opportunity in gold and gold stocks (see
The Stealth Breakout You May Have Missed) in which gold prices have staged an upside breakout to all-time highs even as assets in the gold ETF GLD have declined, indicating public indifference, which is contrarian bullish.
It’s difficult to explain gold strength using conventional investment indicators. Gold prices have been most correlated with TIPS prices, which measure the returns of inflation-indexed bonds. But gold reached an all-time high while TIPS have not, which is a negative divergence.
To be sure, gold mining stocks have recovered from an oversold extreme, both on an absolute basis and relative to gold prices, but that still doesn’t explain the mystery of the gold rally.
If individuals aren’t buying gold, who is? Despite the frequent mutterings of gold bugs of a distrust of fiat currencies and governments, it’s central bank demand that’s been driving up gold prices, according to a
Business Insider article.
Central banks bought 1,037 tons of gold last year, just shy of the all-time high of 2022, according to the World Gold Council. There’s a strong case for record buying by countries including China and Poland this year, the council said in January.
The buying has been mainly led by China.
China’s central bank added gold to its reserves for a 16th straight month in February, extending a long buying spree that’s helped to support the precious metal’s surge to a record high.
Bullion held by the People’s Bank of China rose by about 390,000 troy ounces last month, according to official data released Thursday. That takes total holdings to 72.58 million troy ounces, equivalent to about 2,257 tons.
Arguably, Chinese demand is driven by geopolitical considerations of de-dollarization. Western initiatives to seize Russia’s offshore reserves to fund Ukraine’s war against Russia have arguably raised Chinese urgency to diversify its foreign currency reserves. Such flows tend to be more policy sensitive and less price sensitive.
The next market phase
In summary, my review leads to the conclusion that markets are indeed signaling a cyclical recovery. The sideways pattern of the cyclically sensitive copper/gold ratio has been distorted by gold strength, which has mainly been driven by central bank demand.
So why would you stay short in such a scenario ? Seems like you should be long.
I am on record as being long-term bullish and tomorrow’s publication discusses those issues. You have to distinguish between a tactical trading short because of an extended market and a short based on a long-term investment view.