Currency/Commodity Markets The biggest problem that we have with gold is that we do not like copper. Not, of course, that we have been right on copper this year but that is somewhat beside the point.
The chart compares the ratio of gold futures prices to copper futures prices with 1-month LIBOR futures (short-term U.S. debt prices).
The idea is that copper does better than gold when short-term interest rates are rising and then gold prices outperform copper when yields are falling. That part, at least, is fairly straightforward so now that we are arguing in favor of lower interest rates we have to be positive on gold... relative to copper.
So... we expect gold prices to rise relative to copper prices but we are still not positive on gold. Why? One of the reasons is shown below using the spread between copper and crude oil futures prices.
The chart below compares the spread or difference between copper prices (in cents) with crude oil prices (in dollars and multiplied by three times).
From 2000 through 2005 the spread moved back and forth within an expanding triangle. At the end of each year the spread would be at an extreme and then it would work back the other way. In other words, at the end of 2001 copper was ‘high’ relative to crude oil so at the end of 2002 crude oil was ‘high’ relative to copper.
As 2005 came to an end we were aware the copper was not only ‘high’ relative to crude oil but that the ratio was also up near the upper resistance line. Our expectation was that copper prices would underperform crude oil through to the end of 2006 so we felt comfortable carrying a negative metals view. Especially so, of course, because we were arguing that commodity prices in general should have reached a top.
The chart at bottom was set up in its present form close to a year ago and all of the lines on it have not been altered in any way. You can see what our expectation was through 2006 for the spread between copper and crude oil. To put this into some form of perspective if crude oil prices ended the year at, say, 60 and the spread fell to -40 then copper prices would have declined to around 1.40 (i.e. 140 minus 3 times 60 equals -40).
Continuing on... if our basic view was that we would close out 2006 with crude oil prices between 50 and 60 then we were also looking for something sub-1.50 for copper. We were aware, however, that the ratio of gold to copper prices was also ‘too low’ so we expected once interest rates finally peaked that gold prices would rise relative to copper.
At the upper extreme concurrent with the BOTTOM for short-term yields the gold/copper ratio tends to rise towards 5:1 but since it would likely take a year or more for yields to grind lower our sense was that something closer to 3.5:1 or perhaps as high as 4:1 would be more fair.
If our forecast was for something like 1.40 copper and a 3.5:1 ratio between gold and copper then gold prices closer to 500 seemed reasonable which left us with no better than a neutral view on gold. When all was said and done (and, as is usually the case, more was said than done) what surprised us the most was the moon shot rise in copper prices this past spring but to this very day it is our conviction that if there is one market that we should continue to hold a negative view it has to be the base metals.
Short-Term Views Finishing up our thoughts we suspect that the reason copper prices were so strong was because, in a sense, it was necessary. The charts argue that the cycle was due to end when the ratio of the SPX to the share price of PD returned to a level comparable to 1982 and 1994. In order for that to happen the markets had to push copper prices higher and then higher still until the SPX/PD ratio fell below 15:1.
We once again show the comparative view of the Nasdaq Composite Index and the ratio between crude oil futures and the U.S. 30-year T-Bond futures. Our argument was that once the crude oil/TBonds ratio made a peak we would be at the lows for the Nasdaq and through trading yesterday the comparison has done a very nice job for us.
A shorter-term and somewhat more specific view is shown below right using the Nasdaq 100 Index (NDX) futures and copper futures.
The idea here is that strength in copper goes with weakness in the big cap tech stocks and vice versa. In mid-August the NDX futures hit a peak around 1590 that coincided with a bottom for copper intraday at 3.35. Those still appear to be the key numbers with copper futures retesting 3.35 on Wednesday and the NDX futures trading up to 1590.00 yesterday. If the Nasdaq manages to push above 1590 at some juncture we would expect lower copper prices.
Below we show the CRB Index and the yield index for 10-year U.S. Treasuries.
Recently the CRB Index broke the rising support line and over the past two days the yield on 10-year Treasuries has slipped below support at 4.80%. The problem is that the U.S. employment report due this morning could send bond prices and yields very quickly higher or lower. The intermarket argument is that weaker commodity prices go with lower yields and through trading yesterday both remain below support.
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