Monday December 03, 2012 10:37
When I'm goin', I mean, when I'm REALLY goin' I feel like a... like a jockey must feel. He's sittin' on his horse, he's got all that speed and that power underneath him... he's comin' into the stretch, the pressure's on 'im, and he KNOWS... just feels... when to let it go and how much. Cause he's got everything workin' for 'im: timing, touch. It's a great feeling, boy, it's a real great feeling when you're right and you KNOW you're right.
Fast Eddie in “The Hustler” (movie, 1961)
Dec. 3, 2012
My Nov. 19, 2012 commentary used a series of pool games from the 1961 movie “The Hustler” to describe the recent interaction of copper and gold. Two weeks ago, it appeared that the red metal was on the cusp of a winning streak against the venerable store of value. Played by Fast Eddie, copper began a run on the table Wednesday as gold dropped from the mid-to low $1700s while copper dipped but then closed just below its session high. The follow-on shots were breath taking - Thursday though Friday’s close brought the red metal to 5-week highs of $3.6500 per pound while the yellow eked out $1,712.7, barely above the key-$1,700 support level.
The November commentary stated that the, “…give-and-take between cooper and gold provides clues to where markets may head next; copper as the nimble player of global growth and gold as the sage opponent who can quickly switch his game from commodity to safe-haven asset to alternate monetary unit.” This week’s price action left gold playing as a monetary unit of diminished interest while global monetary easing and expectations of improving global demand propelled copper price. This fast-paced game could quickly change on faltering U.S. fiscal cliff negotiations or new data that challenge a growing consensus that the Chinese economy has made a bottom. This weekend China released the official PMI for November, an expansionary 50.6 – a 7-month high up from October’s 50.2. For now, the smart money remains on Fast Eddie.
Gap-Down from the “Grand Reversion”
The gold-to-copper price ratio, or GCR, has been a reliable odds maker since late October (Ref 2). My commentaries have established 500 pounds per ounce as an alert level - ratios above that level favor bearish bets on copper; trending below keeps Fast Eddie racking wins. The previous analysis stated, “A bullish ratio compression to 470 by years end would comfortably support the October highs for both metals and require only a modest dip below the 6-year trend line…” By Friday’s Comex close copper accelerated the pace, the GCR closed at 469.2 pounds per ounce and below the 6-year trend currently at 481.5 pounds per ounce. This is shown in the following updated plot of Figure 1:
Figure 1 – Gold-to-Copper Ratio (GCR) Gap-Down from the “Grand Reversion”
This week’s gap-down in ratio is all the more impressive because it follows a period of calm coined the “grand reversion” and a bearish breakout to the alert level in early-November (Note 1).
Now that the GCR is testing the 470 pounds per ounce level, it’s reasonable to ask whether further compression results in higher copper prices at gold’s expense (copper bull, case #1) or whether they will both move higher with the red metal marching at a slightly quicker pace (copper bull, case #2). Here’s the math for the second case given October’s highs for the current most active Comex futures contracts:
$1,800 per ounce (Oct. 5 high, Feb. contract) / $3.829 per pound (Oct. 2, 2012 high, Mar. contract)
= 470.1 pounds per ounce
For this case, staying at or falling below the 470-level leaves room for gold to retest the $1,800-level and copper to move above $3.8 per pound in the coming weeks.
Unfortunately for gold, the first case appears more likely in the present market environment. The copper-gold correlation map of Figure 2 explains why:
Figure 2 – Gold-Copper Rolling Correlation Map
The map is a plot of the 3-month versus 1-month gold-copper rolling correlation (rho) which results in a correlation “trajectory” when the market data is connected (red diamonds and lines). After Federal Reserve Chairman Ben Bernanke’s Aug. 31, 2012 Jackson Hole speech hinted at a third round of quantitative easing, gold switched its game and the 3-month correlation with copper rapidly became more positive (vertical green arrow). When both the 1- and 3-month correlations crowd into the upper-right corner of the map (i.e. rho>0.8), gold typically behaves a commodity. This is the most bullish region for the yellow metal when copper is on the rise – copper and gold prices move together supporting case #2.
However, in early November copper prices fell as gold prices rose on U.S. post-election jitters and a worsening economic situation in Greece. By Nov.9, the GCR bearishly peaked at 501.4 pounds per ounce. As shown in Figure 2, the trajectory transitions from vertical ascent to a right-to-left track as the short-term correlation quickly fades (note the large separation between data points compared to the tight cluster in the far upper-right corner).
Further ratio compression suggests gold may remain range bound as copper prices push higher (weak correlation). The current range mean is $1,715 per ounce, very near Friday’s closing $1,712.7, supports the current $3.6+ per pound copper. At the $1,750 range top, copper could see $3.7+ per pound but may fall short of the October highs of $3.8+ per pound.
It's a great feeling…
The best scenario for copper to break October resistance is a red and yellow metal return to the upper-right corner of the correlation map. The worst case is re-expansion of the GCR above the 500 pound per ounce alert level mimicking or exceeding the price action earlier this month. Somewhere in-between is the present weak short-term correlation of copper and gold with a modest compression from current levels. The ratio stability analysis of the Nov. 19 commentary argues the worst case is unlikely as 2012 draws to a close leaving Fast Eddie with an extended winning streak or memories of a terrific November game.
Ref 1: Copper and Gold - The Bank Shot (Richard Baker, Kitco commentary, Nov. 19, 2012)
Ref 2: Copper and Gold - In the Eye of the Storm (Richard Baker, Kitco commentary, Oct.30, 2012)
Note 1: As explained in my previous commentary, the “grand reversion” (Fig. 1, dotted ellipse) is a period when the daily GCR (red triangles), 3-month moving average (solid reddish-brown line) and 6-year trend (green line) gracefully converged. Importantly, not only do the three curves intersect, they flatten in slope with respect to each other defining a “stable” or stationary span that followed Federal Reserve Chairman Bernanke’s Aug. 31 Jackson Hole Speech and extended through late October. The speech hinted at the present round of monetary easing.
November witnessed the daily GCR bolt past the 500 pound per ounce “alert” level (solid red line) as uncertainty about the fiscal cliff, Europe sovereign debt and Chinese growth intensified. The GCR peaked at 502 on Nov. 9, the first time above this level since the market turmoil of last October that followed the downgrade of U.S. debt in early August 2011. In June of this year the GCR came close to the alert scoring 492 June 9 compared to 538 on Oct. 3, 2011.
The GCR first broke the 500 pound per ounce level Dec. 12, 2008. It peaked at 621 pounds per ounce Feb. 20, 2009 during some of the worst months of the 2008-2009 Financial Crises. By the Mar. 9, 2009 S&P 500 low, the GCR had declined to the low-500 levels as copper prices recovered from their 2008 lows. By early summer 2009 the GCR bullishly courted the low-300 level.
Note 2: $1,715 per ounce is the geometric range mean between the November highs and lows (Feb. contract: $1,757.1 high, Nov. 23; $1,674.4 low, Nov. 5).
By Richard Baker, CP Value Analytics