What is the Gold-to-copper ratio and why is it important? And more importantly, what could it be telling us?

 

The Gold-To-Copper Ratio Health Check
Copper is often referred to as a barometer for economic growth and gold has historically been the safe-haven, a risk-off asset of choice for investors, so naturally comparing the two allows one to take a decent look at broader market sentiment.

Why Copper?
Copper is one of the most widely used metals from both established and emerging economies and on top of that it is the only base metal used throughout all aspects of industrialization. Therefore increase in industrialization equates to an increasing demand in copper which ultimately relates to higher copper prices. For this reason, the metal holds the moniker of “Dr. Copper.” and why we can use it as an indicator of economic growth.

The Ratio Explained
In layman’s terms, the gold-to-copper ratio is the current gold price divided by the current copper price. However what is more import is what this ratio indicates and how it can help us get a firmer understand of the macro forces at play within the market. The gold-to-copper ratio is effectively a visual representation of risk-on/risk-off sentiment. The higher the ratio means that fewer people are buying copper and more are buying gold so what we see is a risk-off sentiment, meaning that people are more cautious with their money and investments, sticking to low-risk products. The lower the ratio equates to the inverse, vis-à-vis risk-on sentiment and more stimulus into the economy.

Gold-to-Copper Ratio Historical Traits
In June of 2016, the story on everybody’s radar was bond yields at the lowest since the middle of the financial crisis with the U.S. 10-year yield printing lows at 1.3579% in and then for the next few weeks we saw the yield sit at around the lows and the 1.50% level. Was the gold-to-copper ratio signaling a shift to us? The ratio peaked in early September 2016 but very quickly began to tumble as Gold prices started to see sell-offs and Copper started to see pretty heavy buying, this resulted in seeing the ratio price drop by about a third. It was during the second leg lower for the ratio that we started to see a bid in bond yields and the transition to a more risk-off environment, which we can see in the chart below that shows both the U.S. 10yr Bond yield (orange line) and the Dow Jones Industrial Index (white shaded line) begin their rally higher.

U.S. 10yr Bond yield & Dow Jones Industrial Index

So how can we utilise this within our trading? To quote Samuel Goldwyn “The harder you work, the luckier you get.” and in this case, the harder you work to understand the interconnectivity of financial markets the ‘luckier’ you get with trading. Understanding how certain assets can be used to evaluate market/economic sentiment allows you to move away from being dependent on the obvious indicators, i.e. economic data & mainstream media sources and will enable you to be ahead of the curve, active as a pose to reactive.

So, with the Gold price just popping above $1200 an ounce and Copper prices pushing lower on the back of poor Chile exports, we could see the gold-to-copper begin to push higher again, was the Gold-to-copper ratio flashing a warning to us before the significant equity market sell-off on Wednesday the 10th? Will a push higher in the ratio signal a further sell-off in equities? We will be watching closely, both the commodity prices and equity indices to see where the market takes us next.

By Alex Simcock

This article is written by a GO Markets Analyst and is based on their independent analysis. They remain fully responsible for the views expressed as well as any remaining error or omissions. Trading Forex and Derivatives carries a high level of risk.

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