For the past 5 years, there has been a fairly clear positive correlation between the copper/gold ratio and the U.S. 10-year Treasury yield. Recently, however, the copper/gold ratio has increased nearly 2-fold due to higher copper prices and lower gold prices, and the increase in the U.S. 10-year Treasury yield has been painless in comparison.
Why has the copper/gold ratio and the U.S. 10-year Treasury yield diverged so much, based on their performance over the past 5 years?
In this regard, strategists believe that the correlation will be influenced by two factors: an uneven global economic recovery and a prolonged period of low interest rate policies by central banks, both of which have a significant impact on copper and gold prices, leading to a significantly higher copper-gold ratio, but less so on U.S. bond yields.
Right now, even with rising inflation expectations, central banks, including the Federal Reserve, have pledged to keep interest rates low for an extended period of time in order to support economies hit hard by the epidemic. In addition, market expectations for economic recovery have become more optimistic in light of the vaccine news, boosting demand for copper as an industrial metal and dampening demand for gold as a safe-haven asset, with the copper-to-gold ratio rising sharply as a result.
Ole Hansen, Head of Commodity Strategist at Saxo Bank, stated.
“Central banks have shown that they can accept higher inflation and will not immediately raise rates because of it, so the correlation between the copper/gold ratio and the U.S. 10-year Treasury yield is likely to break down as the economy grows and without a rate hike.”
The correlation between the copper/gold ratio, a macroeconomic indicator favored by the “new king” Gonack, and the US 10-year Treasury yield may not necessarily break down, but the correlation coefficient between the two will probably undergo some adjustment.
Harry Tchilinguirian, head of commodity strategy at BNP Paribas, noted that the similarity between the copper/gold ratio and the U.S. 10-year Treasury yield in the past does not mean that there is a cause-and-effect relationship between the two, nor does it mean that the correlation will remain the same.
Currently, the copper market is experiencing a wave of investor frenzy not seen in 10 years, and copper prices are expected to continue to rise, driven by both short- and long-term factors, which could lead to further deviations between the copper/gold ratio and the U.S. 10-year Treasury yield in the coming period.
On Monday, London copper rose to $7,700 per ton, a nearly seven-year high. And, this month marks the eighth consecutive month of gains in copper prices, marking the longest rally since 2011.
According to Luke Sadrian, chief investment officer of Commodities World Capital.
“Copper prices have now risen more than 70 percent from their March intraday lows, reminiscent of the price spikes of the early 2000s, as a surge in Chinese orders kicked off a commodity supercycle,”
Sadrian also stated.
“With the December contract expiring on Wednesday, hedging in the options market will also fuel the rally in copper prices, and there are a large number of calls with a strike price of $7,800 per tonne outstanding, so if prices break through that level, contract sellers may have to rush to buy copper futures to cover their short positions.”
In addition to the above short-term drivers, there are a number of long-term macro factors that will drive copper prices higher still. The prospect of a global economic recovery increases expectations of rising inflation, which will benefit the overall commodity market. In addition, governments are putting money into green stimulus programs, which will also require the consumption of large amounts of industrial metal for infrastructure.
Susan Bates, an analyst at Morgan Stanley, wrote in a Monday report.
“With strong support from macroeconomic drivers, copper prices are expected to reach another record high in 2021 and rise to $7,716 per tonne in the fourth quarter of next year.”
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