Where is the copper/gold ratio going?
Russia’s invasion of Ukraine has caused massive volatility in metals and other commodities over the past few days. The incursion has also resulted in multinational sanctions that could extend to commodity companies with significant Russian interests like Polymetal International.
The copper/gold ratio is a widely used metric to gauge market sentiment and expectations regarding the global economic recovery. This ratio doubled between the start of the coronavirus pandemic in March 2020 and October 2021, but has since lost 10% as shown in the graph below. Since Covid-19, gold and copper have seen their prices rise. Copper climbed more than gold between the first half of 2020 and the first half of 2021, as industrial metals benefited more than precious metals from the global economic rebound. However, due to a number of geopolitical concerns and inflationary anxieties, gold began to outperform copper from late October 2021. Stagflation risks have recently increased as economic agents anticipate that the Russian conflict will -Ukrainian could have a negative impact on the economy. production while increasing inflation.
How does the copper/gold ratio relate to US 10-year bond yields?
The widespread use of copper as a base metal and gold’s elite status as a safe-haven asset combine to produce insightful indicators, especially when combined with US bond yields. Historically, the copper/gold ratio and US 10-year bond yields have moved together. Indeed, when the copper/gold ratio rises, expectations improve for a stronger economic recovery and a positive economic outlook. This is consistent with rising US bond yields amid rising inflation expectations and positive growth.
On the other hand, when this ratio falls, it means that traders are increasingly concerned about the economic outlook, and these movements have in the past been linked to falling US Treasury bond yields. However, over the past year, the gap between these two metrics has widened due to rising commodity prices as well as massive demand from China. China had also put in place some environmental policies last July, which required companies to turn to low-carbon resources. Due to the forced shutdown of a number of Chinese smelters following rising energy prices, China has also faced internal shortages of several metals, fueling its strong demand.
The gap between the two metrics widened further after the US Federal Reserve (Fed) injected monetary stimulus into the economy, keeping bond yields at bay. Bond yields therefore no longer reflect the current inflation scenario, despite the pace of price increases reaching multi-year highs in recent months. However, that could change this year if the Fed reverses monetary stimulus, raises interest rates and shrinks its balance sheet. If that happens, the spread between the US 10-year bond yield and the copper/gold ratio could narrow. For now though, increased monetary stimulus has left the difference between 10-year bond yields and the US inflation rate at an all-time low at -5.7%, as seen in the second graph below.
Multinational sanctions against Russia have been particularly harsh on mining companies as investors sell stocks. Evraz is down 40% today. Polymetal International, one of the world’s largest gold and silver producers, is down 18% after falling about 50% in the past few days. Several sanctions also target transport, which can make it much more difficult for producers to charter planes to export their production. Although Russia is believed to still hold a huge amount of gold, the country is unlikely to find many willing buyers as its banks face tightening circumstances.
Russia is a major producer of a number of metals, including gold and 40% of the world’s palladium, which significantly complicates commodity supply chains.
The heightened threat of stagflation has pushed gold prices further higher in recent months. The Russian-Ukrainian war adds to inflationary concerns, but at the same time reduces economic output, meaning the economy will slow due to trade restrictions. Over the past few weeks, many factors have pushed gold higher, but copper has remained broadly flat as its economic outlook isn’t as bright as it was a few months ago.
Europe has also had to deal with significant increases in natural gas bills, as the Nord Stream 2 project was abandoned by Shell and British Gas from Centrica. As Russia is one of the main suppliers of gas to Europe, this has resulted in the closure of a number of gold mines and other metals due to rising energy costs, leading to a rise in gold prices.
Gold has further faced shortages due to prolonged drawdowns in South America affecting production due to the immense amount of water required. This, coupled with the Chilean government’s threat to nationalize a number of mines, has also caused a spike in demand for the metal.
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US 10-year bond yields have been rising since last July, matching the rise in the copper/gold ratio as market risk appetite increased and investors moved away from safe havens. Robust earnings and earnings along with higher expectations for the year ahead reassured investors that the economy is recovering. However, if the Ukrainian conflict lasts much longer, there is a lot of uncertainty about the direction bond yields will take.
On the one hand, there are inflationary threats. If inflation increases, investors will not be willing to invest in government bonds because they will suffer losses. On the other hand, if there is major turmoil in the market, US Treasuries are considered the safest bet.
In this type of economic scenario, gold has traditionally outperformed. Gold has already risen around 6% this year, and last week the metal hit an 18-month high, hovering around $1,973.96 an ounce. With inflation hitting multi-year highs in recent years, gold prices have risen significantly in recent months. The outlook for the metal turned briefly bearish when it looked like a number of central banks would raise interest rates in the coming months. However, the Fed did not raise rates in December, leaving room for gold to rally, especially as more investors flock to safe havens after the Russian invasion.
With a large percentage of Russian gold unlikely to leave its borders in the near future, gold prices are likely to continue to rise as a shortage gradually grips global markets. Investors’ concern over the timing of interest rate hikes in the United States could also push them towards gold as a safe option, which could further boost prices.
With copper likely to follow a similar path due to its high demand and multiple uses, it is likely that the copper/gold ratio will continue to rise over the coming months as the world waits for markets to readjust. and fill the supply gap.