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Copper & Gold – The Long Ride from Lehman Brothers

Tuesday October 08, 2013 14:29

Monetary expansion, particularly since the financial crisis, has been a massive boon for the gold price. Gold was trading around $830 an ounce before Chairman Ben Bernanke announced QE1 in November 2008. Gold and the U.S. dollar usually move in the opposite directions and gold's perceived status as a hedge against inflation is also burnished when central banks flood markets with money.

Incrementum AG of Liechtenstein (Ref: R.J. O’Brien Weekly Metals Report, Sept. 30, 2013)

Oct. 8

In the heart of North American gold country we are embraced by snow topped mountains that pre-date the Rockies and High Sierra, basins that fill the nostrils with alluvial dust from hundreds of millions of years ago, and stars in a night sky that recall the birthplace of metals that we hold so dear – a big sky over a small chunk of earth abundant with mineral treasures beneath our boots.

Gold likes it old, copper too. Extruded from the bowels of the earth through tectonic collisions and extensions, volcanism and faulting, the yellow and red metals have had quite a long ride together in geologic time.

For market participants, the slow price journey of this pair since the Lehman Brothers bankruptcy may seem marked in geologic time punctuated with shooting star brilliance to record highs and earthshaking quakes to mineshaft lows. In truth, it is only a few weeks more than five years that these two began their long ride from the deep basin of the 2008-2009 financial crises over lofty mountain tops of recovery expectations and now cautiously clop-clopping into yet another valley of easy money, dysfunctional U.S. government and sputtering global growth.

Around the campfire, the sage store-of-wealth reminds his red-headed compadre that when the headlines fade and monetary stimuli taper, their trusted trail guide of supply and demand will re-emerge and deliver them to quieter pasture and calmer waters, “He may already be waiting round’ the bend – that’s what the data show. Now, if that guide just doesn’t get bushwacked at Debt Ceiling Gorge…”

The Red & Yellow Metal’s Price Journey

The Fig. 1 scatter plot of Comex copper versus gold prices is a good way to illustrate the long ride from the Lehman Brothers Bankruptcy filing to Friday’s close:

Figure 1 – Comex Copper vs. Gold (Lehman Brothers to present) – Price Trajectory

Each price pair is represented by a diamond and the diamonds are connected by lines to create a “price trajectory” form Sept. 15, 2008 to Friday. Key dates along the red and yellow metal’s journey are indicated by larger diamonds with black outline. Besides the endpoints, these include the Aug. 5, 2011 U.S. debt downgrade and the April 12 start of the recent gold price downdraft.

Quantitative Easing – One, Two, Three…

As the headline quote suggests, monetary easing on a global scale has been a major influence on the trail ride depicted in Figure 1. Figure 2 overlays the three phases of U.S. quantitative easing on the copper and gold price trajectory:

Figure 2 – Comex Copper vs. Gold (Lehman Brothers to present) – QE Phases

Copper was quick to react to the market calamity caused by the Lehman Brothers bankruptcy. Prices crashed from mid-$3 per pound to sub-$2-levels (red arrow) before the first phase of quantitative easing, or QE1, was introduced in late-November 2008 (green arrow and trajectory trace). The copper price descent is nearly vertical in this chart as gold held a range of $700-960 per ounce.

The startling efficacy of QE1 to reflate copper prices is illustrated by the light green box with high/low dimensions of gold price (width) and copper price (height). The red metal recovered more than its Lehman Brothers level touching $3.7 per pound and gold enjoyed a brief foray above $1,200 per ounce. Copper giant Freeport-McMoRan and its primary product were already on an uptrend before the S&P 500 found its mineshaft in March 2009. After the end of QE1 in the spring of 2010, copper briefly slipped below $3 per pound but then joined its yellow metal companion on a trail to even higher ground.

Introduced in November of that year, QE2 put the pair in full gallop inflating copper prices above $4.50 per pound to record highs while gold found new glory above $1,400 per ounce (reddish brown arrow, trace and rectangle). As the second program rolled on, the red metal dipped below $4 per pound again as gold pushed above the $1,500-level. Copper then comfortably rebounded above $4 per pound as QE2 came to a close in June 2011.

With another debt ceiling debate on the near-horizon, Figure 2 cautions how traumatic a negative outcome can be on the metals market. Following the U.S. debt downgrade, copper prices crashed again followed by gold’s safe-haven jolt to an all-time Comex record high of $1,923.7 per ounce on Sept. 6, 2011.

The current phase of U.S. quantitative easing (QE3 – purple arrows, trace and rectangles) has had a curious influence on the metallic pair with a dramatic bifurcation marked by the gold price downdraft of April 12, 2013. Prior to April (first purple rectangle), the red and yellow metal traded in a range of $3.3-$3.8 per pound and $1,500-$1,800 per ounce respectively. In early April, gold began its long descent from $1,500 to $1,200 territory in June to Friday’s close at $1,309.9 per ounce (second purple rectangle).

Copper prices followed gold lower trading $3 to $3.40 per pound just barely overlapping the pre-April range and closing Friday at $3.301. In general, QE3 witnessed a clockwise rotation of lower gold and copper prices from the inflated levels of QE2 (note curved purple arrow). By providing a floor to even lower prices, QE3 has tended to “stabilize” metal prices into narrow trading ranges.

Table 1 lends some perspective to the above travel log by showing the start-to-finish percentage price and valuation changes for each quantitative easing phase:

* The QE3 cycle is ongoing; the values given are for Oct 4, 2013

Table 1 – Comparison of Three Quantitative Easing Cycles

QE1 drove gold and copper prices significantly higher (up 33.2% and 94.7%). However, with copper gaining more than gold, the yellow metal lost considerable relative value to its red companion (i.e. on ounce of gold bought nearly 140 pounds less copper at the end compared to the beginning of the cycle; a devaluation of 31.6%).

The end-to-end performance of QE2 was more even but much less impressive (up 10.8% and 11.5%) even though there was an inflated all-time record for copper price in-between. Gold lost only slightly to copper in terms of valuation (-0.7%).

In contrast to the preceding phases, the ongoing QE3 phase appears to be headed for lower gold and copper prices (by Friday’s close, down 26.1% and 13.9%) with another gold net loss of value to copper (down 14.2%).

Reversion to the mean…

Reversion to the mean provides a technical basis for explaining the so far contrary behavior of QE3. Figure 3 adds two pieces to the puzzle. The first is a “line-of-fair-value” established by performing a linear regression of the entire data set of Figure 1. The resulting straight (solid) line divides the scatter plot into two regions - a price pair above the line indicates copper trading at a premium to gold; below the line, copper trading at a discount. The slope of this line is the price sensitivity or “beta” of copper to gold from the Lehman Brothers bankruptcy to the present.

Figure 3 – Comex Copper vs. Gold (Lehman Brothers to present) – Price Sensitivities

The slope of a second (dotted) line is the “mean valuation” or average gold-to-copper ratio of the data intersecting the line-of-fair-value at the 5-year mean of gold and copper prices (yellow diamond).

Importantly, as summarized in Table 2, the Oct. 4, 2013 closing prices and relative valuation together with the 1-month and 3-month moving averages are all very close to the 5-year mean and mean valuation. This strongly suggests that a reversion to the longer term mean is in progress:

Table 2 - Reversion to the Mean

R.J. O’Brien Copper & Gold Forecast

Monday morning, R.J. O’Brien’s updated brackets for copper and gold prices in their Weekly Metals Report:

Copper is range bound in very quiet trading. Support is seen in and around the $7,110 [$3.225 per pound] area basis three months while overhead resistance comes in at around $7,310 per tonne [$3.316 per pound].


Technically speaking, the gold price has broken down with its first support level at $1,320 basis spot failing to hold. The next strong support level is thought to be around $1,270 to $1,275 basis spot London. Overhead resistance now comes in at around $1,350 to $1,355 per oz basis spot London. (Monday)

Figure 4 superimposes these ranges on Fig. 3:


Figure 4 – R.J. O’Brien Copper & Gold Price Projections

The RJO upper bounds (green lines) for copper and gold intersect very near the 5-year mean (yellow triangle). The lower bounds (red lines) intersect close to the line-of-fair-value. It is noteworthy that the copper price on the day of the Lehman bankruptcy filing is just beyond the present RJO level of resistance.

What next?

Given the growing uncertainty about present U.S. government shutdown and fast approaching debt ceiling, it is nearly impossible to predict the next moves for copper and gold. A very negative outcome (e.g., sovereign default) could create a price trajectory anomaly many times more severe than the 2011 U.S. debt downgrade with unimaginable consequences.

If, however, cooler heads prevail in Congress and crisis is averted, copper and gold prices could transition from the highly charged environment of monetary expansion to a more classic market of supply and demand as global stimuli is eventually reduced. The orderly reversion to the mean of Figure 3 and Table 2 suggest this process may already be underway. Even with a backdrop of dire headlines, the price volatilities of copper and gold are relatively benign and both metals are trading in the fairly narrow ranges shown in Figure 4.

Although Table 1 presents a mixed picture of how quantitative easing affects metal dollar prices, one consistent characteristic is the erosion of gold’s relative value to copper for all three cycles. My Sept. 16 commentary, Gold Trapped in a Value Wedge, shows that this devaluation is not unique to the red metal but is also apparent when measured against a basket of key commodities.

Monetary easing appears to elevate the relative value of “real things” so that an ounce of gold buys fewer pounds copper and barrels of oil than at the program’s inception. As QE3 grinds along, this implies that a sideways price action for copper could presage lower gold prices in the near term. With respect to Figure 3, this would be a transition from copper trading at a discount to a premium again – a state rarely achieved since the 2011 debt downgrade.

As monetary accommodations fade and inflation expectations return, this trend should reverse again in gold’s favor with the return of sustainable higher prices replacing today’s transient headline rallies.

Someday the red and yellow metal will ride again into the sunset of more bullish markets – in geologic time perhaps only a few microseconds away.

By Richard Baker, CP Value Analytics
Eureka, Nevada


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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