While investor sentiment has digressed from euphoric levels, as previously discussed, a slew of constructive technical developments have appeared recently … the latest being a key breakout in the copper-gold ratio.
The copper-gold ratio (orange line) simply takes the price of copper, divides it by the price of gold, and plots the reading daily. When the ratio is rising that means copper is outperforming gold and when the ratio is falling that means gold is outperforming copper. What is the significance? Gold is considered a safe haven for investors with far less industrial/economic use than coppper. It is mostly viewed as a storage of wealth. Rising gold prices have often signaled economics contraction and/or investor fear. Conversely, copper is a key industrial metal with countless economic applications, especially in building construction and electronics. Thus, copper tends to perform well when the economy is strong or expected to be strong.
The grey line on the chart is the US Treasury 10YR Yield (TNX). Interest rates tend to run parallel with the copper-gold ratio. Intuitively this makes sense because rising interest rates typically come during economic expansions and falling interest rates are often characteristic of accommodative monetary action taken during times of economic hardship.
Notice today that the copper-gold ratio has recently climbed out of a visible trough and interest rates have generally trended upwards too – this adds credibility to the deferral of rate cuts and higher for longer narrative. This could also provide tangential support that investors want to see a soft landing more than they want to see rate
cuts.
As it relates to equities, consider the relative strength chart below between the United States Copper Index Fund (CPER) and the SPDR Gold Trust (GLD) on a 3.25% scale, which simply means that each column change (into either Xs or Os) requires about 10% of outperformance. When this chart is in Xs CPER is outperforming and when the chart is in Os GLD is outperforming. The buy/sell signals (green and red boxes, respectively) are objective long-term indications of relative price strength while the columns Xs/Os indicate shorter-term trends of relative price strength. Notice that CPER returned to a relative strength buy signal against GLD earlier this week! (The highlighted row is ongoing, and not projected to end today.)
The table below shows the performance for the S&P 500 via cap weight ETF (SPY) and equal weight ETF (RSP). Note that before ETF inception we used underlying index data. While CPER was on a relative strength buy signal against GLD (green box on the chart above) SPY generated an average return of 29% and a median return of 21%. When CPER was on a relative strength sell signal against GLD (red box on the chart) SPY generated an average return of 9% and median return of 15% – which is not bad, but materially lower than when on a buy signal. Similar performance is observed for RSP.
To conclude, the recent buy signal in favor of CPER has historically been a good sign for stocks. In fact, the worst return SPY has experienced (between signal changes, not necessarily drawdown, since the early 1990s) was when CPER was on a buy signal with a 12% decline in 2011… which is pretty tame. There will never be an “all clear” signal when investing and no two markets are the same. After all, there were plenty of periods in the table above where equities continued to perform well amidst relatively weak copper prices. For instance, the S&P 500 just gained 30% while CPER was on a sell signal against GLD.