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

Is The Market Done “Crashing” or Is This A Fakeout? (What To Do Now)

Around Christmas Eve nearly everybody you know was freaking about their account and the safety of their retirement. Now we’ve bounced up around 5% or so in the last five days and people already seem a lot more calm. When people are terrified, buying is generally what you want to do. When complacency sets in, things may still be shaky. We covered this briefly in our recent article about Apple’s fall. It’s called a sentiment indicator.

So we just fell off a cliff in December and now we’re bouncing up a bit. The Wall Street term for this is a “dead cat bounce*” typically used by as*holes who want to sound like they’re market technician geniuses. We find it’s better to picture a tennis ball. You throw the ball way up in the air (or you drop it from high up) and what happens? It’s going to fall at high speed, hit the ground, bounce back up (never quite reaching as high as the first peak) then fall and keep on bouncing until it stops completely. So the question is, the ball already getting thrown back up into the air? Or is it just bouncing from that big drop?

bull trap possibility
The second red arrow is theoretical but likely, even if it doesn’t go below the last one.

Nobody can say. Anybody who says they know 100% is full of it. Our “educated guess” is that the market is going to get thrown back into the air very soon, but this is probably just the bounce. If it stops at the levels we’re seeing now, that’s nearly a 50% bounce off the fall (which is a pretty typical pattern to see.) But we need to know if that December low you see above is “the ground”

Buying back in right now may be buying into what’s called a bull trap. The drop down of December made the bulls cry (people who think the market is going up.) This bounce makes the bears cry as they lose money thinking they’re wrong (people betting the market is going down.) The bulls now laugh at the bears and kick them in the d*ck  while buying back in. Then the bears take back over and the market falls back down and the bulls lose all hope. When the bulls lose all hope is when you REALLY want to buy. Might wanna pad that crotch…

So how the hell does anybody make decisions if we don’t know what’s going to happen? Simple: you buy in chunks. It’s what’s called dollar cost averaging. Let’s say you have $5,000 you want to put in to Apple (AAPL). You could put all that money in right now, but if the market falls back down again you’re going to be one of those crying bulls. Now if you buy as many shares as you can around $1,250 right now (you’d get 8 shares for about $1,216) then in a month you buy as many shares as you can for another $1,250, then another the next month etc. In 4 month’s you’ll have around $5,000 worth of Apple that you bought at 4 different prices. You’ve then averaged in to your position and taken much less risk than just buying a huge chunk at once and risking a huge drop. If you make contributions to your 401k or IRA and it automatically buys into mutual funds, you’re essentially already doing this without realizing it.

For people who think the market is going to drop more and possibly pass the previous lows, this may be a good time to take on a small short hedge position while hedges are a bit cheaper (if you haven’t already). If you don’t know how to do this, we’re not going to cover it here, because you’ll almost certainly end up doing something too risky at this point.

Right now, stocks are the best value that they’ve been in quite a few years. We’re getting into crazy sale prices on some stocks and others are just reverting to their long term averages (based on price/earnings) Either way, the market is no longer way overpriced like we’ve seen for the last few years. It’s not an exact science, but most estimates are showing the market is now around a forward P/E of 14 – 16.  Basically the historical average. If you don’t at least have a watch list of things you’ve been wanting to buy: FIGURE IT OUT NOW. This time zone right now is probably the last time you’ll see things this cheap for quite a while. It’s completely understandable to wait for a return to the uptrend (with confirmation of that bottom) but to us it’s looking like a damn good time to average in.

UPDATE: Sentimentrader just posted a very similar analysis of the market movement. Highly suggested reading. 

 

Note: If you’re a beginner and wondering why the chart says SPY that’s an ETF (exchange traded fund) that tracks the S&P 500. The prices aren’t the same as the index you see on the news, but that fund is made to match it exactly. It is the most commonly bought ETF for people who want to “buy the market.”

 

*The idea being that even a dead cat will bounce a little if you drop it from high enough.

Is Real Estate In A Bubble? The Only Chart You Need

When the economy busted out in 2009 everybody noticed how much real estate prices plummeted around the country. You probably heard at least a few horror stories about people who owed more on their mortgage than their homes were worth (underwater)Now, the majority of Americans have recovered enough to be able to try to buy a home or an upgrade from their current one. The problem is that those bust out prices set a precedent. People love seeing on the news that economy is strong “MAGA derrrrrrrp!” but don’t want to pay strong economy prices. They want the income of “things going well”, but the home prices of “the economy is in the shitter”. So in the interest of pulling the veil back of where housing stands it then makes sense to compare how much money people are making vs. how much homes actually cost.

The National Association of Homebuilders/Wells Fargo publish a study called the Housing Opportunity Index, which pits income and home prices against each other.

Infographic: Soaring House Prices Hurt Home Affordability | Statista

You can see that the yellow Opportunity line doesn’t deviate a huge deal from its average. It typically hangs right around 60. When that line dropped to 40 in Mid 2006 is when we got in trouble. What the number is showing you is the percentage of households with a median* income that can afford to buy a median priced home. The key is that the number doesn’t have to move very much to have a huge impact. Just think that if it moves from 60 to 40 that means approximately 20% less of the population can afford to buy a home.

Now here is the catch to that chart. Its really damn hard to average out costs when you include places like San Francisco and Bumf*ck, Mississippi. This is why you need to go local and look at your closest metro area. The easiest way to go about it is to just google something like “Los Angeles Housing Opportunity Index”. With that search we can find the most recent LA housing opportunity numbers.

california 2018 3rd quarter housing.JPG

This tells us that right now 30% of people in the Los Angeles metro area can buy a home and that the household minimum income to qualify for a mortgage is $112,200. San Fran you need to make over $200k. Over 3.5x the national average. Bummer, right?

Here’s the thing though, real estate doesn’t just “crash” locally. The LA opportunity number is less than half of the current national number of 56.4 from the the NAHB/Wells Fargo study**. Some areas will always run at a premium because of where they are and what they offer, but we have to look at the big picture. So…

Real Estate might be ungodly overpriced in your area, but nationally we are far from a bubble. Homes are just slightly above the historical average pricing. With a National average of 56.4% of households in the US able to afford a home, it appears people holding out for a crash to buy a home in LA, NY, San Francisco, etc may have to wait quite a while.

If you want all the data for the NAHB/Wells Fargo Opportunity Index, including metro areas and histories, you can get it all here in nerdy little excel spreadsheets. Otherwise, Google is your friend…

BONUS TRIVIA: A commonly sited rule of thumb is that in healthy economic conditions the cost of your home should be no more than 2.6 years of Household Income.

Household Income x 2.6 = Home Price

Stay Tuned to learn about what we can learn about real estate from two guys named Case and Shiller!!

More info to digest:

Housing in the US is too expensive, too cheap, and just right. 

75 percent of LA residents can’t afford to buy in LA

*For those that don’t remember, median means middle. It’s not the average, but it’s halfway between most and least of something.
**Yes, we realize on the CA opportunity numbers, their US average is a little lower. Likely due to timing and data sources of the studies/calculations but it’s close enough for our purposes.

 

Eliminate Fear of the Bull Market Crash with One Piece of Info

Concerns are being thrown around by financial media that this may be the end of the bull market. Stansberry Research just put out this infographic that sums up why that’s total bullshit. Bull markets end with a bang, not a whimper. That being said, if you’re having trouble sleeping at night because of the volatility, it’s probably time to adjust your allocation and stop losses. Times like this are great for seeing what your real risk aversion is vs. what you think it is.

102618-RMD-SP-500-Gains-in-the-Last-Six-Months-of-the-Past-10-Bull-Markets-1-1