Oil, Copper & Gold: Together Again?Monday February 29, 2016 15:20
Disseminated gold deposits in Paleozoic limestone - Windfall Pit,Eureka, Nevada
July 13, 2015
A Scary Week
It is Monday morning, a Greek deal has been reached, Shanghai Composite is up over 2%, following government intervention, and gold has notched down to $1,150 per ounce on a falling euro and rising U.S. dollar. The analysis below is based on Friday’s close – does it change my outlook for the yellow metal? Not one bit.
Gold had a scary week but less scary when compared to oil and copper. Following the crashing Shanghai Composite and continued uncertainty in the Eurozone, Comex gold regained almost all its losses closing at $1,157.9 per ounce Friday. In stark contrast, Nymex WTI and Comex copper were down 3.5% and 12.0% respectively for the week. Bearishly, gold broke the "higher-lows-since-November" trend line Wednesday and came within two dollars of its March 17 low ($1,145.9 versus $1,143.8, August contract). More ominously, the red metal plumbed an intraday low of $2.381 per pound on the same day - a price not seen since mid-2009. On the day before, WTI escaped sub-$50 per barrel by just 58 cents.
Although initially following both down the mine shaft, the lustrous one showed greater resilience than key commodities – a redeeming trait demonstrated since late-2014. This morning’s trading hasn’t materially altered that character. Let’s put some light in the shaft and see what’s going on.
Commodity or Currency?
On March 31, I asked Janet Mirasola, Director of the Wells Fargo Securities Metals Group, for her commodity value of gold. I had posed the same question nearly a year before when she answered with a sobering $850 per ounce. The commodity value is taken to be the yellow metal’s base value after the premium for such things as safe-haven or monetary hedge are stripped away. This time, she said, "I am not sure gold really has a commodity value any more – it’s just another currency …"
This is an interesting observation on two levels: for some time gold has not behaved as a commodity and its price action has exhibited low currency-like volatility.
My commodity value for gold, derived by comparison to key commodities, fell close to Mirasola’s 2014 prediction by the end of January ($800 per ounce) and then dipped slightly further on the fateful St. Paddy’s Day ($787). To her point, there is a lot of daylight between these floors and the actual price of gold that has meandered near the $1,200-level. From April 2013 to November 2014, that difference was much smaller; less than $200 per ounce and occasionally by just a few dollars. On Friday, my commodity value calculated to be $855 which represents a sizable gold premium exceeding $300 per ounce (details on this calculation can be found in my August 25, 2014 Kitco commentary: Oil, Copper & Gold on a Slippery Slope)
A gravity analogy explains the relationship. Without the propulsion of safe haven or monetary hedge, the yellow metal is typically pulled back in line with commodity prices by the gravity of historical norms. In the current declining commodity environment, gold should follow copper and oil to lower prices. Since the yellow metal has avoided its three-digit commodity value to date, it is reasonable to conclude that it somehow achieved “escape velocity” from its commodity brethren in late-2014. The reason for this high premium is debatable but its existence, undeniable – gold is not behaving as a commodity.
Secondly, currencies generally exhibit much less price volatility than commodities. Volatility can be thought of as the wiggle in day-to-day prices compared to their average over a period of time. Figure 1 is a plot of 3–month versus 1-month volatility of Comex gold and the euro currency from the March 31 Mirasola comment to July 10:
Figure 1. Volatility Map of Comex Gold & Euro (March 31 to July 10, 2015)
In this context a volatility less than 1% is considered “low.” From her statement in late-March, gold volatility (yellow trace) has declined on both a 1- and 3-month basis and, for the most part, with less volatility than the euro (purple trace). Although neither entered the 1% box (shaded green intersection), gold ended the tumult of last week with a subdued 1.07% 1-month number and 1.38% for 3-months. The comparative numbers for the euro are 1.13% and 2.02%. The arrows at the terminus of each trajectory imply future direction – increasing volatility for gold and declining variability for the euro. Although this weekend’s decision on Greece may impact the trajectories some, I expect both to remain in 1-2% territory for the near term.
As shown in Figure 2, a comparison with copper illustrates the volatility difference between gold and another metal:
Figure 2. Volatility Map of Comex Gold & Copper (March 31 to July 10, 2015)
Copper (red trace) ended the week with a 1-month volatility of 2.54%, tamed down from a 3-month number of 4.60% but with price variability higher than either euro or gold. A comparison with WTI is even more severe scoring 5.82% and 4.57%.
A correlation map suggests that gold is rejoining key commodities in price direction. Figure 3 is a plot of 3-month and 1-month rolling correlations of gold with oil and copper from June 1 to last Friday:
Figure 3. Correlation Map of Comex Gold & Copper (June 1 to July 10, 2015)
Although positively correlated with these commodities in early June (dashed ellipse), gold correlations with oil (gray trace) and copper (red trace) both entered negative territory this summer. The events of last week reversed this trend and now all correlations are positive and increasing (red and gray arrows).
If the present trajectories persist, it is reasonable to expect gold to follow the price direction of these key commodities but with much less volatility.
Gold ratios are least disturbed (i.e. most stable) when the prices of commodities and gold move together. With both oil and copper correlations in the upper right quadrant, their ratios with gold are not expected to change significantly. For example, although the Greek decision wiggled all three prices in early morning trading, Friday’s gold ratios have not materially changed (456 pounds of copper for an ounce of gold versus 453 pounds this morning – 22.0 barrels of light sweet crude versus 22.1 barrels).
Positive correlations imply stable gold ratios suggesting gold will maintain its significant value premium relative to copper and oil.
Average ratios since the Lehman Brothers’ bankruptcy gives this some perspective. The Lehman mean gold-to-copper ratio is 406 pounds per ounce; WTI is 15.9 barrels per ounce. Compared to this morning’s ratios, the gold premium relative to the average is therefore a respectable 50 pounds per ounce for copper and 6 barrels per ounce for oil.
With commodity giant China on tenterhooks and an Iran deal in the works, both oil and copper may have more downside in the near term. If the present correlations persist, gold may also move lower. Importantly, the price changes for the yellow metal are not expected to be severe given its months of quietude.
Last week’s copper low may also be it for some time. In her weekly Metals & Macro Highlights, Janet Mirasola posted today, “Seasonal strength had clearly not been apparent this summer, but given ongoing supply problems stretching from Chile to Zambia, the recent lows at $5240/50 [$2.3768/$2.3814] now appear to have been a steal to many who had been waiting for a dip.”
Oil sage T. Boone Pickens commented last week on CNBC Business News that he still believes oil to make $70 per barrel by the end of the year. In stating his case, Pickens noted that the earliest Iran could come online is 2016 when global demand is expected to improve and supply still feels the drag of 2015 U.S. rig reductions.
Given that backdrop and assuming the first Fed rate hike is already priced in, I believe the yellow metal should uneventfully wander in the $1,100 to $1,200 per ounce range for the remainder of 2015. With relatively stationary gold prices, recovering commodities will slowly erode the present value premium with higher prices – historical gravity is a powerful force.
From the heart of North American Gold country – Cheers!
By Richard Baker
The Eureka Miner
Photo by Mariana Titus