The Copper–Gold Ratio and Greenback Results
Institutional asset managers use the copper–gold ratio as one of many 10-year Treasury yield’s main 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 truthful worth yield is under 2%.” Because the divergence endured earlier this 12 months, the copper–gold ratio was, in Gundlach’s phrases, “screaming that the 10-year ought to go decrease.”
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 might weaken underneath sure market circumstances.
Copper and gold are each dollar-denominated commodities that exhibit detrimental correlations with the foreign money. Each day information 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 enhance commodity costs for non-dollar consumers. Certainly, a powerful greenback has a tightening impact on world financial actions, in keeping with Financial institution for Worldwide Settlements (BIS) evaluation. The next charts bear out this relationship.
Copper Futures vs. Greenback Index
Gold vs. Greenback Index
Because the 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 way 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 must strengthen the greenback and push short- and longer-term charges greater.
In a Goldilocks financial system with no coverage shift, nonetheless, detrimental shocks ought to gas flight-to-haven flows to each the greenback and Treasuries. That is what occurred throughout the commodity rout of 2014 and 2015 and once more throughout the 2019 “repo disaster.” 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 world greenback demand pushed by geopolitical components might act as headwinds for each the greenback and Treasury securities. In “Struggle and Peace,” Credit score Suisse analyst Zoltan Pozsar mentioned geopolitical currents might scale back overseas reserve managers’ urge for food for greenback bonds. In such a state of affairs, a weaker greenback might 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 pattern might persist.
Overseas Holdings of US Treasuries
Because the greenback and Treasuries more and more reply to world macro catalysts, the copper–gold ratio and different, much less dollar-sensitive, indicators might 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 mirror the views of CFA Institute or the writer’s employer.
Picture credit score: ©Getty Photographs / bodnarchuk
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