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Oil, Copper & Gold – Herd Mentality?

Monday May 06, 2013 16:04


This Hebrew word, which literally means turning into a rhinoceros, has come to describe herd mentality (Elon Gilad, Haaretz, April 26, 2013)

Gold is usually quite comfortable in the commodity herd. The yellow metal can also play a safe-haven in crisis, monetary alternative or some combination of the two. Lately, any signs of alternative or multiple roles have vanished as gold develops an unusual affinity for global commodities oil and copper.

All three have descended from the sunlit savannahs of 2012 to dark valleys of price decline. On an intraday basis, the yellow and red metals stumbled deep into bear-infested forests during April-May - more than 20% below their peak prices last year. Oil reached the edge of the forest, touching 20% in mid-April. All three regained ground by Friday’s close but the recovery is less than stellar.

How does one interpret this market signal? What does it mean when the traditional safe-haven seeks safe-haven among the retreating herd?

Uncommonly high correlations

Since mid-2006, gold has correlated positively with global commodities oil and copper more often than not. I prefer to look at the 1-month and 3-month rolling correlations together – the former serves as a short-term alarm that can relay impending market change; and the latter, a dependable gauge of relative performance over the mid-term. Both being positive is generally a good indication that gold has rejoined the reference commodity, mixed signs conjure alternative roles at play and two negatives is clearly a danger sign: gold has abandoned its commodity mate at a gallop.

For nearly seven years the short-term and mid-term rolling correlations of copper and gold were both positive 60% of the time, with oil at 59%. Times when copper and oil both enjoyed positive short- and mid-term correlations with the yellow metal are a respectable 39% (Note 1).

April 2013 is curious because not only did gold positively correlate with oil and copper but the correlation was uncommonly high for a simultaneous occurrence. From April 18 to April 30, the 1-month and 3-month gold-to-oil and oil-to-copper rolling correlations were greater than +0.8. This has happened less than 1.5% of the time since mid-2006. The longest event was 8-market days at the beginning of the second round of U.S. quantitative easing (aka QE2) in November 2010. The recent event is nine market days – the herd is clearly moving as one, but to where?

The correlation map

My Feb. 11, 2013 commentary for Kitco introduced a scatter plot of short- and mid-term rolling correlations as a method for illustrating not only correlation but direction and rate-of-change as illustrated in Figure 1.

Figure 1 – Correlation map with percent-time histories (mid-2006 to present)

In this example, the 3-month (Y-axis) and 1-month (X-axis) correlations of copper with gold are updated each market day and the correlation pair is plotted as a red diamond. Connecting the day-to-day points (red lines) creates a correlation “trajectory” of not only correlation values but also implied direction (red arrow). The resulting plot or correlation map is divided into four quadrants. The upper-right quadrant (green) represents positive 3-month and 1-month correlations of the red and yellow metal; the lower-left (red), negative correlations. In the upper-left and lower-right quadrants, the correlations have mixed signs and are called “Transition Zones” (yellow).

For this analysis, a correlation exceeding 0.8 for both short- and medium–term calculations is considered very strong and defines the darker green area within the upper-right quadrant.  I have coined this region the “Rhino Zone” as a play on the headline Hebrew neologism that denotes herd mentality – when gold finds itself with copper in the rhino zone, it is closely moving with the red metal in price (Note 2).

Trajectories that enter the bottom-left quadrant are in the “Danger Zone” when gold leaves the herd with conviction. In Fig. 1, as falling short-term correlation erodes a longer-term positive relation, the correlation trajectory moves counter-clockwise from a corner of the rhino zone, through the (- , +) transition zone to finally the danger zone where all correlations are negative.

Finally, the space between day-to-day data points or trajectory “velocity” is important to note as well as correlation value and direction. In this example, the spacing is greatest as the copper trajectory bolts from the green upper-right quadrant and then quickly accelerates though the transition zone. As it falls into the danger zone of negative correlations the data points bunch up as the trajectory velocity slows appreciably.

The historical perspective

The previously cited percent-time statistics for oil, copper and gold are included in Fig. 1 from mid-2006 to the present. This is an important interval because gold has steadily gained value relative to copper and oil over this period (Ref 1). The percent-time oil-gold (WTI) and copper-gold (Cu) correlation pairs spent in each of the upper-right and lower-left quadrants are given in the large colored boxes. Also shown is the percent-time of simultaneous occurrences of oil-gold and copper-gold correlations with common signs (Cu & WTI). Similar statistics are given for the rhino zone in the small dark green box.

Both oil and copper spent roughly 60% of their time in the upper-right quadrant, 39% of that time together, reinforcing the notion that gold price follows commodity prices a majority of the time. Very strong gold correlation (>+0.8) with oil and copper is much less frequent at 6% with only 1.5% of that time scored for both commodities in the rhino zone.

When gold goes its own way, correlations are typically mixed in sign (“Transition Zones”) or worst case, descend to the “Danger Zone” of negative correlation. Oil finds itself in this latter condition only 10% of the time and copper 14%. Oil and the red metal both registering short- and mid-term negative correlations is the least likely condition at 3.9%.

As noted in the February commentary, some of the most horrific moments in the commodity space have occurred after oil and copper trajectories enter the lower-left quadrant together.


Fig. 2 is an updated correlation map for oil and copper from mid-February to Friday’s close:

Figure 2 – Updated correlation map (mid-February to present)

By the February 11 commentary, the paths of oil and copper trajectories ominously crossed into the danger zone in concert as the Chinese calendar moved from dragon to snake. Not escaping the curse of simultaneous negative correlations, both oil and copper experienced steep price declines since. Disappointingly for gold enthusiasts, gold price not only declined but led the herd to new 2013 lows.

Figure 2 illustrates how the three came together as the correlation trajectories left the danger zone in February with steadily rising 3-month correlations (green arrow). In early April, both the copper-gold (April 1) and oil-gold (April 11) correlations made sharp “UFO-like” turns towards the rhino zone and wasted no time reaching the small green square (note the wide spacing of data points in each trajectory). Just before entering the zone, which extends from April 18 through April 30, Comex gold made its intraday low of $1,321.5 per ounce on April 16. Inside the box, Nymex oil made its low of $85.9 per barrel on April 18 and Comex copper followed just outside at $3.0425 per ounce on May 1.

Interestingly, the data-spacing in and near the rhino zone is very close suggesting the members of the herd are not only strongly correlated but have achieved a very stable relation. By Friday’s close, there was weakening of this condition as both the copper-gold (red arrow) and oil-gold (gray arrow) correlations move away from the zone.

Reviewing the record from mid-2006 to the present reveals a key shift in the relative performance of oil, copper and gold:

The 8-day visit to the rhino zone in November 2010 was followed by rising prices for all three as the effects of QE2 began to inflate the commodity space. The recent 9-day visit suggests a mirror image of declining prices that find little lift from the present round of quantitative easing, QE3. The former occurred in a gold bull market; the latter in a gold bear market. Whether this presages a reversal in the secular gold bull market is yet to be seen.

From a Fibonacci viewpoint, the retracement from recent lows compared to February highs has been lackluster. By Friday’s close, oil has fared the best breaking the key 61.8%-level at 71.3%. Neither gold nor copper have achieved a 50% retracement yet; the yellow metal is just a nose above the 38.2%-level at 38.8% and copper is below at 35.2%.

It may be a long trek back to the sunlit savannah of higher prices for this tired herd of rhinos.

Note 1: The record for this analysis is Jul. 20, 2006 to Friday’s close, May 3, 2013 – a total of 81 months. NYMEX Western Texas Intermediate (WTI) crude was selected for this study because of its greater liquidity compared to global benchmark ICE Brent crude. COMEX copper is the benchmark for the red metal. Percent-time is defined as market days in for a given correlation state divided by the total market days.

Note 2: My Feb. 11, 2013 commentary defined a larger region in the upper-right corner of the map for strong correlations (i.e.>0.6) and called it the “Bullish Zone.” The moniker was appropriate then because over that study period, gold was still in its long-term bull mode: as gold prices trended higher, so did base metal prices when correlations were positive. The jury is out on whether this remains the case now that gold and copper are both following bearish trends.


Ref 1: Oil, Copper & Gold – All in the Family (Richard Baker, Kitco commentary, Jan. 22, 2013)

Ref 2: Oil, Copper & Gold – Beware the Snake? (Richard Baker, Kitco commentary, Feb. 11, 2013)

By Richard Baker, CP Value Analytics


Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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