COPPER AND GOLD HAVE BEEN TRENDING IN OPPOSITE DIRECTIONS ALL YEAR -- FALLING BOND YIELDS EARLIER IN THE YEAR FAVORED GOLD -- THE RECENT RISE IN THE 10-YEAR TREASURY YIELD FAVORS COPPER -- COPPER AND ITS MINERS MAY BE FORMING BOTTOMS
STRONG JOBS REPORT ON FRIDAY BOOSTED COPPER BUT HURT GOLD...Friday's impressive jobs report took a lot of traders by surprise resulting in strong buying of stocks; which was accompanied by selling of Treasury bonds and other safe havens like gold. Riskier assets gained which included copper prices. Crude oil also had a strong week following the announcement by OPEC and its allies to cut production next year. That helped make energy the week's strongest sector. My main interest here, however, is the relationship between copper and gold. And why the red metal (copper) has started doing better than the yellow metal.
Chart 1 compares the prices of gold to copper since the start of the year. The first takeaway is that they've been trending in opposite directions. Gold turned up during May and continued rising until September; it's been declining since then. The red bars show copper dropping between May and September (while gold was rising). Since September, copper has been rising (while gold has been falling).
In my opinion, the main reason why they've been trending in opposite directions is because they each send different messages. Gold tends to do better when investors are nervous about the global economy and the direction of stock prices. That's why gold is considered to be a safe haven. Copper, on the other hand, is an economically-sensitive commodity that is highly correlated to the strength or weakness of the global economy. The industrial metal does worse when investors are pessimistic; and better when they turn more optimistic. Which explains why they reacted differently to Friday's strong jobs report. Investors sold gold and bought copper. But there's a way to make more sense of their recent trends. And that's to consider the direction of Treasury bond yields.
NOW LOOK AT BOND YIELDS...The point of the next chart is to show that the direction of Treasury bond yields plays an important role in the copper/gold relationship. The red line is a relative strength ratio of copper divided by gold. The solid green area plots the direction of the 10-Year Treasury yield. The tight correlation between the two is striking. And makes it clear that they've trended very closely in the same direction all year. Their positive correlation is confirmed by the line in the lower box which shows their 60-day Correlation Coefficient moving between 1.00 (perfect correlation) to .75 for the last six months.
BOND YIELD IMPACTS COPPER/GOLD RATIO... The chart also shows both dropping together between April and August. And then rising together since the start of September. There's a logical explanation for that. The direction of bond yields is a barometer of investor confidence in the global economy. Bond yields around the world fell between the spring and summer of this year as fears of a global recession took hold (and the U.S. yield curve inverted). That encouraged investors to favor safe havens like gold (and bonds) which usually do better in that weaker environment. In addition to being a safe haven, gold is a non-yielding asset which does better when bond yields are falling. Like it did starting in the spring. At the same time, the negative warning from falling bond yields hurt economically-sensitive copper. Those trends have reversed since the start of September when bond yields started rising. And the yield curve turned positive as a result. Rising global bond yields over the last three months have signaled more optimism on the global economy; and encouraged investors to buy riskier assets like stocks and copper; and sell safe havens like bonds and gold.
PRICE OF COPPER MAY BE BOTTOMING...The daily bars in Chart 3 show the price of copperending the week on top of its 200-day moving average for the first time since the spring. It also touched the highest level since July. It needs to do more to turn its trend higher. But it's looking stronger. So are stocks tied to the red industrial metal.
Chart 4 shows the Dow Jones NonFerrous Metals Index also ending the week above its 200-day average. That index includes stocks mainly tied to copper. A close above its July peak might be enough to turn its major trend higher. Copper stocks have also been showing relative strength of late. That's the thin green line that's been rising over the last two months. Copper shares have also been the strongest part of the Materials SPDR (XLB) over the last three months (while gold miners have been one of the weakest). But there's another important global link influencing the price of copper. And that's the direction of Chinese stocks.
CHINESE STOCKS MIGHT BE BOTTOMING...A lot of the global concerns over the past year has been due to the trade dispute between the U.S. and China. And that dispute has made Chinese stocks among the weakest in the world over the last couple of years. That has a direct bearing on copper (and other commodities) because China is the world's biggest buyer of those commodities. Which includes half of the world's copper supply. So any signs of strength there could have a positive impact on commodity prices here.
Chart 5 plots the Shanghai Stock Index over the past two years. After surging during the first quarter of this year, it retraced two-thirds of those gains between April and August. Over the last four months, Chinese stocks have regained some lost ground and are looking stronger. But it would take a move above its July/September highs to turn its trend higher (see flat trendline). That could give a big lift to the global economy. And it might take a stronger Chinese market to increase demand for commodities like copper.
