The copper-gold ratio and dollar effects
Institutional asset managers use, amongst other things, the copper-gold ratio Leading indicators for the yield on 10-year government bonds. As the spread between bond yields and the ratio widened within the third quarter of 2022, Jeffrey Gundlach, CEO and chief investment officer of DoubleLine Capital, cited the context, noting: “The fair value yield on 10-year US Treasury bonds is below 2%As the divergence continued earlier this year, the copper-gold ratio was, in Gundlach’s words, “I’m screaming that the 10 year bond should be lowered.”
Copper-gold ratio in comparison with 10-year Treasury yield
However, as asset managers concentrate on the metric’s relationship to Treasury yields, we’d like to know the market catalysts that influence this relationship, particularly the U.S. dollar, as there are signs that the metric’s usefulness may diminish under certain market conditions .
Copper and gold are each dollar-denominated commodities which have a negative correlation with the currency. Daily data from 2020 to 2023 suggests a correlation coefficient of -0.10 between copper futures and the dollar index. Gold’s correlation with the dollar index had a coefficient of -0.31 over the identical period.
These metrics make intuitive sense: the appreciation of the dollar against local currencies should increase commodity prices for non-dollar buyers. Actually, a A powerful dollar has a tightening effect on global economic activity, based on evaluation by the Bank for International Settlements (BIS). The following diagrams show this connection.
Copper Futures vs. Dollar Index
Gold vs Dollar Index
Since the dollar is a standard influencer of copper and gold valuations, the gold/copper ratio largely neutralizes this effect, as shown by their -0.01 correlation with the dollar index. While this increases copper’s sensitivity to economic growth, it also increases tracking error in comparison with dollar-influenced instruments akin to US Treasuries.
Treasury Yield and Dollar Valuation: Nuanced Dynamics
The correlation coefficient of the 10-year Treasury bond yield and the dollar index reached as much as 0.82 in our evaluation period from 2020 to 2023. Despite this positive correlation, the dollar’s relationship to Treasury yields is far more nuanced.
During an easing cycle initiated by a dovish Federal Reserve, a weaker dollar tends to correlate with lower Treasury yields. Conversely, a more hawkish Fed should strengthen the dollar and drive up short- and longer-term rates of interest.
However, in a Goldilocks economy without policy change, negative shocks are prone to fuel a flight to protected havens in each the dollar and government bonds. This happened throughout the commodity crisis in 2014 and 2015 and again in 2019.Repo crisis.” The copper-gold ratio and other dollar-dependent metrics should diverge from rates of interest resulting from their positive correlation with the dollar.
10-year Treasury bond yield in comparison with the dollar index
The copper-gold ratio is vulnerable to a macroeconomic paradigm shift
Additionally, shifts in global dollar demand driven by geopolitical aspects could act as a headwind for each the dollar and government bonds. In “War and peace,“Credit Suisse analyst Zoltan Pozsar said geopolitical currents could reduce reserve managers’ appetite for dollar bonds. In such a scenario, a weaker dollar could coincide with weaker Treasuries and increase the divergence between the copper-gold ratio and the 10-year yield. Pozsar suspects that foreign holdings of US government bonds have already declined in recent years This trend could proceed.
Foreign holdings of US government bonds
As the dollar and Treasuries increasingly react to global macroeconomic catalysts, the copper-gold ratio and other, less dollar-sensitive indicators could also be missing recent drivers. And that might undermine their usefulness as indicators.
If you enjoyed this post, remember to subscribe.
Photo credit: ©Getty Images / bodnarchuk
