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Oil, Copper & Gold Transmit a Distress Signal

Gold Country - Roberts Mountains, Eureka, Nevada

Mar. 17, 2014

Last week proved exceptional for gold with a notable bounce in U.S. dollar price and significant value gains relative to key commodities and equities. Safe-haven status has been re-established for the yellow metal given deteriorating conditions in the Ukraine and a slowing Chinese economy burdened with debt concerns. A strengthening euro and yen, the fall of copper prices to sub-$3 per pound levels, reversal of oil prices to the downside and plunging equity markets have all buoyed gold in both U.S. dollars terms and relative valuation.

It is Monday morning and a U.S. stock market rally is underway after more than 95% of Crimeans voted Sunday to secede from Ukraine and join Russia. The markets anticipated this outcome and but may turn south again after details of planned economic penalties imposed on Russia by the West. Comex gold closed at $1,379.0 per ounce Friday, surged to a 6-month high of $1,392.6 Sunday and is now trading within a few dollars shy of Friday’s close – wait and see for the yellow metal.

Kitco Global Editor Debbie Carlson wrote an excellent column last Tuesday on the recent challenges facing metal prices, Silver, Copper Could Weaken Further If Chinese Economic Data Disappoints; Copper Breaks $3/Lb (Kitco News, Mar. 11, 2014). She included a chart that I have found useful for anticipating market turbulence. My chart illustrates the divergence between copper and crude oil relative to gold has widened to levels not seen since the Arab Spring in 2011 or the onset of the Great Recession. Figure 1 is an update of this plot from October 2006 through Friday’s close.

Figure 1 – Copper-WTI Divergence Indicator (Oct. 18, 2006 to present)

This analysis is based on the most active futures contracts for Comex gold and copper, and Nymex WTI crude oil. The particulars of the copper-WTI divergence indicator are explained in the note below. Divergence in the commodity family is rarely a good sign for commodities or other markets, especially when it reaches levels comparable to periods preceding significant market stress. These are shown by red circles above the red dashed line at the divergence level peak reached last Monday, March 10. A reddish-brown circle marks the lower divergence at Friday’s close, March 14.


  1. The divergent spikes associated with Great Recession and Arab Spring 2011 occurred during a period of rising gold and oil prices and falling copper prices
  2. The spikes occurred in pairs approximately 1 month apart
  3. The spikes were followed by volatile markets which included benchmark gold records and precipitous drops in key commodities.

Drilling down at little further…

Fig. 2 expands Fig. 1 for 2014 showing the Copper-WTI divergence from Dec. 31, 2013 through Friday’s close along with important event markers:

Figure 2 – Copper-WTI Divergence Indicator (Dec. 31, 2013 to present)

So far, 2014 has experienced notable flip-flops in both key commodity prices and currencies. The year began with gold and WTI at their year-to-date lows and copper at its high (YTD highs and lows are shown by colored boxes). On March 12, the red metal plumbed an intraday low of $2.909 per pound, nearly 15% below its 2014 debut. By contrast the weekend peak for gold is 16% above its January low. Nymex oil made its high on March 3 of $105.22 per barrel, up 15% but has since traded to sub-$100 levels as China growth concerns have trumped potential energy disruptions from the Ukraine crisis.

The recent trend in currencies has been a strengthening yen and euro versus the U.S. dollar as the Chinese yuan loses considerable ground (YTD highs and lows are shown by colored ellipses; W=weak relative to USD, S=strong). This morning the euro is at new highs and the yuan at new lows for 2014 - the former giving some boost to dollarized commodities; the latter making gold more expensive in Chinese markets. The yuan transition from strength to weakness has been particularly dramatic falling 2.5% peak-to-trough with most of the decline commencing mid-February and a striking 0.5% decline since Friday.

The important inflection for the divergence trace is Friday, Jan. 24 when the DOW Jones Industrials Index fell 318 points. In her pre-market brief the following Monday, Wells Fargo Metals Group Director Janet Mirasola warned:

Global markets continue to fall following Wall St’s 318 point plunge on Friday amidst fears that the reality of a China slowdown and the cracks seen in emerging market currencies may give investors good reason to reduce risk right across the board as they trim portfolios looking for safety after having cashed in on the bull markets of 2013.

From that point forward, Copper-WTI divergence bolted higher, paused briefly in February and then spiked to its March 10 high of 1.68 following the Russian occupation of Crimea, the China Chaori Solar default and bad Chinese export data. To put this in context, the peak divergence for Arab Spring was 1.98 and 1.96 before the first official month of the Great Recession (Figure 1).

My rule-of-thumb is that an indicator greater than 1.5 signals market caution, the mean divergence is 0.63 over the 7-1/2 year record. At the divergent peak, I told Kitco’s Debbie Carlson, “Manning battle stations here. Although the VIX and S&P 500 hardly show much duress, I think the recent copper dive is significant.”

What next?

It is unlikely that market conditions going forward will be a calamitous as those during the Great Recession or following Arab Spring in the fall of 2011. Economic recovery in the U.S. has more solid underpinnings, the China reduced growth expectations are still above 7% GDP and the evolving debt crisis there will probably not manifest Lehman Brothers-scale global consequences.

However, as global stimulus fades, copper prices will respond to the faltering demand fundamentals of slower growth.  If the Ukraine crisis escalates further, oil could reverse higher given the proximity to oil producing countries and its own importance as an energy hub for Europe. Rising oil and gold with falling copper prices could produce a second divergent peak similar to the previous peak-pairs shown in Figure 1. Caution flags shall be raised a little higher for this scenario.

There are several headwinds for gold price. The falling yuan could further impact physical demand from China, the world’s largest consumer for the yellow metal. Another is forward guidance from the FOMC meeting this week that hints at higher interest rates but that outcome is far from certain. Now that the ephemeral $1,350-level has been breached the next challenge will be the $1,430 August high. What next? I will keep my eye on the copper-WTI divergence indicator for the coming weeks for clues.

From the heart of North American Gold country – Cheers!

Note: The copper-WTI divergence indicator, or CWDI, is based on differential rolling correlations of two different time bases. If  CORRELi (Cu, Au) is the rolling correlation of Comex copper and gold prices over time period i, then the differential correlation of Nymex WTI crude and Comex copper relative to Comex gold is:

DELTAi (Cu-WTI, Au) =  CORRELi (Cu, Au) – CORRELi (WTI, Au) for time base i

The CWDI is the geometric norm for two time bases i & j:

CWDIi,j (Cu-WTI, Au) = SQRT (DELTAi (Cu-WTI, Au)^2+ DELTAj (Cu-WTI, Au)^2)

For the above analysis, the time periods are 1-month and 3-month (i=1 & j=3).

Since correlations are bounded by +/- 1, the theoretical maximum CWDI is SQRT(4+4) or 2.83

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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