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Oil, Copper & Gold – Don’t Worry

Monday February 25, 2013 10:41

In your life expect some trouble
But when you worry
You make it double
Don't worry, be happy...

Bobby McFerrin, from the movie Cocktail (1988)

Last week gave market participants a lot to worry about. Monday started out upbeat with Chinese traders providing needed support to the previous week's falling gold prices. Monday was a day off for U.S. markets so all remained quiet on the western front. The broader markets were up Tuesday and the S&P 500 made a new high for the year closing at 1,530.94; Comex gold was only down several dollars form its Friday number. On Wednesday, gold was swept under the rug plummeting to a $1,558.1 per ounce intraday low. On Thursday, gold scored an 8-1/2 month low at $1,554.3 per ounce – a vertiginous fall from grace considering the high for February was $1,687.0, a nearly $133 decline.

Like falling dominoes, the decline in gold prices was quickly joined by sharp reversals in base commodities and a sell-off in the broader markets. Comex copper price was still in decline Friday closing just above its intraday low at $3.5330 per pound ($7790 per tonne) compared to a $3.7925 ($8360 per tonne) high earlier this month. Western Texas Intermediate (WTI) crude shed more than $6 from its February high dipping to $92.44 per barrel before closing Friday at $93.13. Comex gold and the equity markets recovered some ground; the yellow metal finished the week at $1,572.8 and the S&P 500 at 1,515.60, up from its 1,497.29 low Thursday.

There is a long list of reasons for last week’s declines. Some of the larger booger bears are a fear that the Federal Reserve may end quantitative easing sooner than expected as suggested by hawkish debate from its ranks, worsening conditions in Europe as it enters a second year of contracted growth and the U.S. impasse on resolving the upcoming sequester followed by a possible government shutdown later in March - a lot to worry about indeed.

Expect some trouble…

My Feb. 11 commentary threw up a warning flare when the 1-month and 3-month correlations of oil with gold and copper with gold all turned negative. This is a fairly rare market event occurring less than 4% of the time from mid-2006 to the present and often a precursor of market turbulence (Ref 2). Over this same time period, gold has steadily gained value relative to both global commodities. The warning:

If oil and copper negative correlations with gold persist there are two likelihoods. The best case for commodities is a rise in price on improving global economic conditions accompanied by a fall in gold prices. This would erase some of the premium gold has accumulated over the last 6-1/2 years and return gold-to-oil and gold-to-copper ratios closer to historical norms. The worst case would be a dramatic fall in commodity prices as expectations for global recovery sour and gold rewards safe-haven investors with rising prices and possibly new records.

A middle path may be a second turn in the trajectories to positive correlations. Although not supported by recent price movements, a return to the more trodden upper-right quadrant of green [i.e. 1-month and 3- month positive correlations] could present bullish possibilities for all three as gold moves again with commodities (Ref 2).

Last week voted for the middle path as both 1-month correlations of oil and copper with gold turned positive with conviction (Note 1). This is not surprising since all three were headed in the same price direction – down, down. The question is whether these declines will continue or turn synchronously to bullish recovery.

The gold value uptrend remains on solid footing…

U.S. dollar-denominated gold prices have been in decline since last fall leading some to wonder if the 12-year bull run for the Lustrous One has run its course. My view is that if the long-term gold value uptrend relative to oil and copper remains intact, the longer term prospects for gold priced in dollars are good.

The logic behind this assertion is simple – if massive global stimulus eventually inflates the price of oil and the red metal relative to fiat currencies and gold continues to gain value relative to both, the price of gold denominated in those currencies will also rise.

Even with all the market pullbacks last week, the gold value uptrend remains on solid footing.

Figure 1 is an update from my Jan. 22 commentary of the gold-to-copper ratio (GCR) and a 6-1/2 year linear regression model shown from early-August 2011 to Friday’s close (Note 2):

Figure 1 – Gold-to-Copper Ratio (Updated)

The day-to-day GCR data are shown by red diamonds and lines. The solid green trend line that moves from the lower-left to upper-right corner represents ratio expansion (i.e. copper losing value relative to gold). The dashed green lines establish plus and minus 2-standard deviation (2-sigma) boundaries from trend. A 3-month GCR moving average is given by the solid red line.

Figure 2 is a similar plot of the gold-to-oil ratio and long-term trend over the same period:

Figure 2 – Gold-to-Oil Ratio

The day-to-day oil ratio data are given by gray diamonds and lines; the 3-month average is the solid gray line. The trend line and boundaries are green as in Fig. 1. Key dates of ratio peaks as well as the similarity between these two plots together with some notable differences are explained in the Jan. 22 commentary (Ref 1). The time following Aug. 5, 2011 U.S. debt downgrade is key in putting the recent market action in proper perspective.

In both Fig. 1 and 2, gold has lost value to copper and oil since early November (i.e. ratio compression for both) but the deviation from the 6-1/2 year trend is not extreme as illustrated in Table 1:

Table 1 - Regression model deviations (mid-2006 to the present)

The maximum deviations of Table 1 all occurred prior to the time record of the two plots. The positive extremes happened during February 2009 for both copper and oil during the depths of the Great Recession.  The negative extreme for copper was a result of QE-2 inflated prices in February 2011 and oil made its low mark when prices exceeded $140 per barrel in July 2008. By comparison, the commodity calamity after the U.S. debt downgrade resulted in less severe maximum excursions falling within 2-sigma as copper and oil prices fell and gold prices rose. The recent negative excursions for both are tamer still and well within 1-sigma.

I do not consider the long term gold value uptrend to be challenged until one or both of these key commodities result in a deviation greater than 2-sigma. A day-to-day ratio expansion for either crossing their respective declining 3-month moving averages (green arrow) could signal a return to greener pasture for gold price.

Gold ratios are very stable

The 1-month stability of gold ratios relative to WTI and copper are also very stable unlike the ratio divergence extremes during the Great Recession or following the U.S. debt downgrade as shown in Table 2. A ratio stability > 3% is divergent and worrisome:

*Stability is defined as the standard deviation of the gold ratio normalized by its mean over the indicated time period – in this case, one month

Table 2 - One-Month Gold Ratio Stability

Don't worry, be happy...

The coming weeks or even months could witness more market volatility and downside for gold prices. Oil and copper will eventually re-price properly given the emerging realities of a Europe in contraction, China which is growing but at a slower pace than more than a decade and the U.S., while showing new signs of life, still facing high unemployment and daunting fiscal challenges.

So far the data suggest that the market influence of these uncertainties pales in comparison to the U.S. debt downgrade market shock or the Great Recession. A gold value trend that continues to move from the lower-left to the upper-right of the chart will support rising gold prices in the long term and very stable gold ratios argue against eminent price crashes in key global commodities.

Nothing trends higher forever and gold will eventually surrender its premium to oil and copper prices as gold ratios return to historical norms. Guessing when this will happen is as futile as predicting when the U.S. Federal Reserve will unwind its accommodative monetary policy. However, closely monitoring the relation of these key commodities to gold is a viable way to anticipate such a change in the market ether. So far, so good - don’t worry, be happy.

Note 1: At Friday’s close, the 1-month correlation of WTI with gold was +0.58 and the correlation of copper with gold +0.74.

The 3-month correlations are still negative at -0.58 and -.17, respectively.

Note 2: The 6-1/2 year record for this analysis is Jul. 20, 2006 to Friday’s close, Feb. 22, 2013; a total of 79 months.


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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