Is the Copper–Gold Ratio a Dependable Leading Indicator on Rates?

The Copper–Gold Ratio and Greenback Results

Institutional asset managers use the copper–gold ratio as one of many 10-year Treasury yield’s leading indicators. Certainly, because the unfold between bond yields and the ratio widened within the third quarter of 2022, DoubleLine Capital CEO and Chief Funding Officer Jeffrey Gundlach cited the connection, observing that “the 10-year US Treasury fair value yield is below 2%.” Because the divergence continued earlier this yr, the copper–gold ratio was, in Gundlach’s phrases, “screaming that the 10-year should go lower.”

Copper–Gold Ratio vs. 10-Yr Treasury Yield

However given asset managers’ concentrate on the ratio’s connection to Treasury yields, we have to perceive the market catalysts that affect this relationship, significantly the US greenback, as a result of there are indicators that the ratio’s utility could weaken beneath sure market circumstances.

Copper and gold are each dollar-denominated commodities that exhibit adverse correlations with the foreign money. Day by day knowledge from 2020 to 2023 point out a correlation coefficient of –0.10 between copper futures and the Greenback Index. Gold’s correlation with the Greenback Index confirmed a coefficient of –0.31 over the identical interval.

These metrics make intuitive sense: The greenback’s appreciation relative to native currencies ought to improve commodity costs for non-dollar consumers. Certainly, a strong dollar has a tightening effect on international financial actions, in response to Financial institution for Worldwide Settlements (BIS) evaluation. The next charts bear out this relationship.

Copper Futures vs. Greenback Index

Gold vs. Greenback Index

For the reason that greenback is a shared enter of each copper and gold valuations, the ratio of gold and copper largely neutralizes this impact as demonstrated by their –0.01 correlation with the Greenback Index. Whereas this magnifies copper’s sensitivity to financial progress, it additionally will increase monitoring error relative to such dollar-influenced devices as US Treasuries.

Treasury Yield and Greenback Valuation: Nuanced Dynamics

The correlation coefficient of the 10-year Treasury yield and the Greenback Index reached as excessive as 0.82 over our 2020 to 2023 evaluation interval. Regardless of such optimistic correlation, the greenback’s relationship with Treasury yields is far more nuanced.

Throughout an easing cycle instituted by a dovish US Federal Reserve, a weaker greenback tends to correlate with decrease Treasury yields. Conversely, a hawkish Fed should strengthen the greenback and push short- and longer-term charges larger.

In a Goldilocks economic system with no coverage shift, nonetheless, adverse shocks ought to gas flight-to-haven flows to each the greenback and Treasuries. That is what occurred through the commodity rout of 2014 and 2015 and once more through the 2019 “repo crisis.” The copper–gold ratio and different dollar-sensitive metrics ought to diverge from charges given their optimistic correlation with the greenback.

10-Yr Treasury Yield vs. Greenback Index

Copper–Gold Ratio Is Weak to Macro Paradigm Shift

Moreover, shifts in international greenback demand pushed by geopolitical factors may act as headwinds for each the greenback and Treasury securities. In “War and Peace,” Credit score Suisse analyst Zoltan Pozsar stated geopolitical currents could reduce foreign reserve managers’ appetite for dollar bonds. In such a state of affairs, a weaker greenback may co-exist with weaker Treasuries and exacerbate the divergence between the copper–gold ratio and the 10-year yield. Overseas holdings of US Treasuries have already declined lately, and Pozsar suspects this trend may persist.

Overseas Holdings of US Treasuries

Because the greenback and Treasuries more and more reply to international macro catalysts, the copper–gold ratio and different, much less dollar-sensitive, indicators could overlook rising drivers. And that would erode their utility as indicators.

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All posts are the opinion of the writer. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially replicate the views of CFA Institute or the writer’s employer.

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