Sunday , 3 December 2023

What Does Current Gold-to-Copper Ratio Mean For Future Price of Gold? (+5K Views)

The gold-to-copper ratio, a key indicator of global economic health, is indicating that globalCopper-USFS economic health is improving which will apply further pressure to gold over the short term.

The comments above and below are excerpts from an article from which has been edited ([ ]) and abridged (…) to provide a fast & easy read.

The gold-to-copper ratio is an indicator of the health of the global economy. It does this by comparing the price of gold to the price of copper and determining how many pounds of copper that one ounce of gold can buy at any moment.

  • This makes it an important barometer of economic health because gold is the most widely recognized safe-haven asset among investors and, therefore, during times of economic and geopolitical distress, it generally tends to perform well, making it a leading gauge of fear,
  • Copper is the exact opposite. Because it is a key industrial metal that is used globally in a wide range of industrial applications, it performs strongly when the global economy is firing on all cylinders.

The above makes [the gold-to-copper ratio the] leading indicator of global economic health and has led to it being commonly called Dr. Copper…

Gold-to-Copper Ratio 1990 to Present

As the chart below illustrates, the ratio has been in decline since hitting a seven-year high in early January 2016 until now where one ounce of gold is capable of purchasing only 458 pounds of copper.

Source: World Gold Council and International Copper Study Group.

The ratio’s sharp decline over the last 12 months can be attributed to a combination of the slump in gold and copper’s recent rally…

The sudden deterioration in the ratio along with the marked divergence of gold and copper prices in recent months has much to tell us about the state of the global economy and the outlook for gold.

Gold-to-Copper ratio vs. Gold-to-Oil Ratio

One striking aspect of the gold-to-copper ratio is that like the gold-to-oil ratio, it is a good indicator of volatility and the likelihood of an economic crisis. As the chart below illustrates there is a close correlation between both ratios…[which] can easily be explained by the fact that copper and oil are both integral inputs for industrial and other economic activity.

Source: World Gold Council and International Copper Study Group.

More importantly, both ratios are relatively good indicators of economic crisis as the chart below (which plots both ratios and each of the major economic crises that have occurred in the last 26 years) illustrates.

This is relatively easy to explain by the virtue of gold’s importance as a safe-haven asset, which investors flock to during times of crisis, while copper and oil both are crucial inputs, which experience heightened demand during times of economic growth.

In fact, as the chart illustrates, the gold-to-copper ratio tends to be a better indicator of crisis with it leading the gold-to-oil ratio.

Source: World Gold Council, International Copper Study Group, U.S. EIA. and author’s inputs.

Nonetheless, it is not a reliable signal of an impending crisis. In January 2016, it reached a seven-year high of 627, yet no crisis eventuated, and since then the ratio has been in decline and is moving back to its 26-year mean.

Is the gold-to-copper ratio a better measure of fear?

Aside from appearing to be a better leading indicator of an impending economic crisis, the gold-to-copper ratio better fits the description of a measure of fear and market volatility. This becomes quite clear when comparing the gold-to-copper ratio to the S&P 500 volatility index or VIX as the graphic below highlights.

Source: World Gold Council, International Copper Study Group, Yahoo Finance and author’s inputs.

While the correlation may not be perfect, it does highlight that the gold-to-copper ratio is a good indicator of fear and volatility. What this tells us is that the ratio is a good indicator for measuring market sentiment rather than providing a hard and fast summary of where fundamentals for gold and the economy are at…

What does the gold-to-copper ratio mean for the price of gold?

It is times like these where markets are fervently acting on sentiment rather than fundamentals that make it extremely difficult to forecast the future. Nonetheless, the gold-to-copper ratio has been relatively accurate in predicting the health of the global economy and the outlook for gold.

What we do know is that with the gold-to-copper ratio at 458, it is well above the 26-year mean of 371 and median of 363. If the ratio were to move back to these figures and with copper trading at $2.47 per pound, then gold would have to fall to between $897 and $916 per ounce, which is 19% to 21% lower than the current price of $1,133.45 per ounce.

[That being said,] such an assumption that the price of gold must fall appears unreasonable in an environment where there is a reasonable level of bullishness surrounding the outlook for commodities, and copper is expected to rally further. If we take the COMEX copper futures for December 2017 delivery of $2.50 per pound, which is 1% higher than the last spot price, gold would need to fall to between $928 or 18% than its spot price if the ratio reverts to either [of] its means.

Nevertheless, while the market may be filled with considerable optimism over the economic outlook because of Trump’s planned fiscal stimulus and investment infrastructure, the global economic outlook is still fraught with risk. These include:

  • the inability of Beijing to sustain its credit-fueled stimulus package which has been a key driver behind the rally in copper and other metals;
  • another crisis erupting in the E.U. because of the fragile state of its banking system coupled with rising nationalism;
  • Trump’s inability to implement the promised fiscal stimulus and trillion-dollar infrastructure investment; and
  • growing instability in the Middle-East, which is fueling a region wide escalation in conflict that is spilling over into Europe.

Each of these and other economic and geopolitical events, if they occur, have the ability to support gold, especially in a reactive market dominated by sentiment rather fundamentals.

Key takeaways

  • The gold-to-copper ratio, particularly after its recent and sharp decline is signaling that softer gold price are here to stay…because it indicates that global economic health is improving, which means that investors should expect a stronger U.S. dollar, higher interest rates, and the reduced risk of another economic crisis.
  • Even if inflation rises, which it certainly will, in such an environment it is unlikely that it will conflate with events required to push gold higher. In such an environment, it is not unreasonable to expect the ratio to maintain its current trajectory and move closer to its historical average at least for the short term…
  • Even if copper rallied to as high as $2.80 per pound, which is a reasonable assumption if China’s economic stimulus and Trump’s planned infrastructure spending overlap, then gold would need to fall to $1,038 per ounce if the ratio reverts to its mean. This is not far off the median price of $1,050 per ounce calculated in my previous article: ‘The Gold To Oil Ratio: What It Tells Us About An Impending Crisis And The Price Of Gold‘.