ROSS NORMAN : Copper/Gold Ratio at the highest since Noah was a boy … what this means for gold.
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Where to start …
Humans are hard-wired to spot patterns and our social and economic wellbeing depends upon our being good at it. And no less so in financial markets.
We all think we can filter out bias and we all have phenomenal libraries of back data to give our views validity. Put simply, to accurately understand the past gives us (potentially) a perfect view of the future … opening conduits to make us wealthy - at best - or a sure-fire excellent dinner party conversationalist at worst … or perhaps just a bore …
However, we rarely have perfect 20/20 vision and there is a cognitive condition or bias called 'apophenia' which is essentially the human tendency to see patterns and meaning in random information. Sadly, we are often fooled.
The point is, pattern spotting is all about correlations, and if you correctly understand these, then you can dramatically reduce your financial risks without significantly impacting your expected returns, suggests Ray Dalio.
And the key thing is, gold is not quite behaving 'normally' these days.
We all seem to be applying different interpretations on what is happening, often to be over-ruled by a new set of data that nullifies that opinion. In short, many in both the bullion market itself and indeed the media struggle to make sense of why gold has recently hit an all time high and continues to consolidate within a high range despite macro data that suggests the opposite; almost every economic model as regards gold's relationship with other assets seems to be broken just now.
The US dollar remains strong, 10 year treasury yields are up 10% YTD, interest rates are “higher for longer” with interest rate cuts being pushed into the long grass - meanwhile inflation is on a downward trajectory and economic conditions improving. Even wars seem to be lessening ; meanwhile institutional demand (using ETF demand as a proxy) is weak with net demand down about 138 tonnes YTD, while Central Bank demand is clearly waning at these elevated levels (especially PBoC in China). On paper, gold should be very significantly in retreat if the arguments that market pundits have been pedalling for the last 50 years in terms of how gold operates, has any validity.
For example there is a bullish view being expounded that we are running out of gold in the ground … and there is only “16 years of mine supply left”. And that's the funny thing … for the last 100 years or more, there has always only ever been “16 years of supply'” left. It's an unchanging production pipeline as new discoveries made are being matched by fresh gold offtake
This is normally a cue where you … the reader … inserts, or as I would put it … “retrofit” your favourite argument .. global debt / geopolitical / secret Chinese purchases etc. Hmmm … well maybe.
There is a book which a friend has recommended (not read yet) called The True Believer which explains our responses when things don't go as we predict … and it underscores our desire to create a false narrative or more typically a conspiracy (to protect the integrity of our personal libraries) ; the rational response should be to re-assess and adjust your factual inputs rather than to ascribe your error to unseen hands or other spurious ideas.
This is similar to the Post Hoc Fallacy which is a very familiar trap that we can fall into. This is the idea that when things are observed to happen in sequence, we infer that the thing that happened first must have caused the thing that happened next.
Anyway … I seem to have gone off piste …. where are we going here … oh yes, it is share with you my own considered view on gold from my own library … read on (guaranteed bias-free).
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The copper/gold ratio would not normally be one of those gauges you would turn to, to understand gold ; it tends to be used as a leading indicator for the macro-economy or for an outlook on treasury yields ; in short, it's an indicator of where we are in an economic cycle and can presage a turning point.
But for the last 3 months gold and copper have been very highly correlated, with a co-efficiency of 0.92 on a 1 year rolling average ; (a correlation coefficient close to -1 or +1 means that the two assets evolve symmetrically, while a coefficient whose value is close to 0 implies no link between the two assets.). Gold has very few reliable correlations just now other than silver … which may simply be a case of a rising tide lifting all boats.
Yes, of course, correlation is not the same as causation …
Gold and Copper – Last 6 Months
Copper reflects industrial demand and economic activity, which stands in contrast to gold, a safe haven asset with limited industrial use. A rising Cu/Au ratio suggests strengthening (peaking ?) economic conditions as industrial copper rallies and safe haven gold declines on a relative basis.
Taking a longer term view, gold and copper very rarely correlate to such a great extent. In fact, we have only been at the current levels 3 times in the last 55 years – in 1978, 1998 and 2006. Coincidence or not, each ratio peak was about 2 years before three major economic recessions – the 1980 crash, the 2000 dot com crash and the 2008 GFC. Just saying.
Economic Crises : 1950+
Since 1st March 2024 both metals have come to the attention of major Chinese speculators on Shanghai Futures Exchange (SHFE) who have taken very significant and highly leveraged positions. SHFE currently warehouses a massive 65% of global physical copper stocks - roughly double the LME level, which has been the global price setter. Meanwhile CME has very, very little metal and the specs who are short are being badly mauled by the squeeze. With the US also banning Chinese and Russian copper it looks like they are rather trapped and have little respite. Whether for the Chinese this is a pure speculative play in copper and gold - or an attempt to corner the markets - or simply a ruse to squeeze shorts is open to conjecture.
Certainly while the copper squeeze has been one hell of a ruse for them, arguably it is much less so for gold (even though gold did achieve an all time high). And it was the out-performance of copper compared to gold that has driven the ratio to near record highs. (Note to those conspiracy guys ... just where are those huge gold shorts you keep talking about ?)
If I am right, then the ratio's predictive power as a harbinger of an upcoming recession may have been compromised. If I am right, it certainly goes a long way in explaining why gold has ignored most traditional drivers with the spot price simply at the mercy of delta hedging by bullion houses. If I am right then gold will be locked into a trading range some way above what most western investors consider fair value – that is to say fresh metal demand will be weak until those options positions roll off - and with a bias to the downside.
Anecdotally we hear that in the West bullion sales remains lacklustre and will remain so until gold finds a physical floor – somewhere around the $2150 level by my estimation. In Germany demand has recovered only modestly from last years poor performance, but is running at roughly half the peak levels of about 3 years ago … so around 80 tonnes per annum ; the problem for the gold market is this involves relatively little fresh metal as they will be buying coins and bars at one cash window and selling at the next. Meanwhile the gold refineries are busy converting metal into a form suitable for the Asian market. The problem is for the Mints and physical bullion dealers who are looking to sell freshly mined gold, and by extension the gold price itself as new metal offtake remains poor just now.
This all makes sense to me … but there's perhaps another cognitive bias in play here …The False Consensus Effect - which is a tendency to over-estimate how much people will agree with you …
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Ross Norman
CEO
Metals Daily Ltd
ross@metalsdaily.com
www.MetalsDaily.com