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Using Metal Prices To Predict Interest Rates (Master-Level Nerdy Sh*t)

This article is going to fall under the “a quick take our word for it and go do your own research” category. Not just our word, Jeff Gundlach (one of our favorite market geniuses) is a big proponent of this indicator.

How many of you have heard the phrase “the Fed is lowering rates”. Well, in a nutshell it means the government is stepping in to control the interest rate that works as the baseline for the economy. Around this baseline, real estate mortgage loans, bank loans, car loans, etc are going to be be tacked on based on a certain percent spread. It’s all very nerdy and boring. For those of you who already DO understand this concept, a rather esoteric trick to predict where interest rates are going (as controlled by the Fed) is to compare the ratio of copper prices to gold prices.

Copper is often called “Dr. Copper”. Because it’s such a staple in construction, the prices going up typically indicate that the economy is humming along. Buildings are being built, cars are being manufactured, you know the drill.  Gold on the other hand is more of a fear/pessimism metal. It has no way near as much use as a base metal like copper. Gold is usually going to go up when investors are worried the economy is NOT going to do all that well. It’s a safe haven metal that people hold on to in case of emergencies.

So long story short: the price of copper going up typically = economic optimism, gold going up = economic pessimism. When you divide gold price by copper price and the ratio is high you can assume an optimistic outlook on the economy as determined by the pricing. Vice versa, a low ratio means pessimism. How does the Fed react to pessimism? It lowers rates, making it easier for the man on the street to borrow money to use for things that will get the economy back in shape (buying bullsh*t, taking out loans on homes, creating jobs, etc)

This may be a bit more succinct explanation from longtermtrends.net :
Gold is the most widely recognized safe-haven asset among investors. Therefore, during times of economic and geopolitical distress it generally tends to perform well, making it a leading indicator 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. This makes it a leading indicator of global economic health and has led to it being commonly called Dr Copper.
The ratio prices copper in gold and it represents the number of ounces of gold it takes to buy an ounce of copper.

 

This is where it gets pretty cool to look at… If you overlay the copper to gold ratio with the Fed controlled interest rate IT’S A PRETTY F*CKING CLOSE CORRELATION. Not exact, but pretty damn close. See below for somebody else’s fancy example of the correlation in action…

copper to gold ratio april 2015 to june 2017

See what we mean? Pretty damn close. Granted that’s an older time line and we’re too lazy to make our own graphic at the moment. But you can use the following two links to find updated graphs.

StockCharts Copper-to-Gold Ratio

Longtermtrends Copper-to-Gold Ratio

 

The current graphs indicate rates going down a bit.coppergold2

Low and behold, the jobs report that came out this morning led to the Fed saying that they may be cutting rates back down.

 

It’s no longer a question of if the Fed will cut interest rates, but when

Fed Begins Debate on Whether to Cut Rate as Soon as June

So that is where we leave you today. Go out and do your own research and know that now you can make an educated guess about where rates are going when people want to sound smart mentioning the economy at “cocktail parties”. But in all seriousness… who the hell still has cocktail parties.

 

 

 

 

Further Reading and Resources:

The Power of Copper-Gold – Jeff Gundlach’s Double Line Fund Report PDF

Validating Gundlach’s 10-yr Treasury relation to the Copper:Gold Ratio

How the Gold-to-Copper Ratio Can Make You a Smarter Investor

Copper-Gold Ratio Signals Treasury Yields May Be Set to Drop (July 2018 Article)

The Copper-Gold Ratio