For many institutional investors, the copper/gold ratio is a valuable indicator for predicting the direction of the US 10-year Treasury yield. However, the key point here is not the absolute value of the copper/gold ratio, but its direction. The recent rare phenomenon in the copper/gold ratio holds significant predictive significance.
First, let’s explain what the copper/gold ratio is. It refers to the ratio between the prices of copper and gold, which is commonly used as an indicator for measuring macroeconomic conditions and inflation expectations. It can reflect the market’s risk preference compared to US Treasuries’ safety.
The reason for this relationship lies in the fact that copper is a globally important industrial raw material, typically used in construction, manufacturing, and electronics. Therefore, its price represents a certain level of economic activity strength and growth expectations. Conversely, gold, as a safe-haven asset, is often influenced by geopolitical risks and inflation expectations.
In general, when the copper/gold ratio rises, it signifies market expectations of economic growth because of increased demand for copper and decreased demand for gold. Conversely, a decrease in the copper/gold ratio may indicate market anticipation of economic slowdown and increased safe-haven demand, thus boosting the price of gold.
Both the copper/gold ratio and the US 10-year Treasury yield are regarded as barometers of macroeconomics and market sentiment, and in certain cases, they can be used to corroborate each other. For instance, when both the copper/gold ratio and bond yields are rising, it may indicate optimism in the market regarding economic growth and inflation expectations. Conversely, if both are falling simultaneously, it may suggest the market’s anticipation of economic slowdown and strengthened safe-haven expectations.
Historical data shows that when divergence occurs between the two, the US 10-year Treasury yield tends to follow the trend of the copper/gold ratio.
During the third quarter of 2022, there was a clear divergence between 10-year yields and the copper/gold ratio: the yield started to rise while the copper/gold ratio moved lower, and this trend continued into 2023. This is an extremely rare phenomenon because the copper/gold ratio has a high historical reliability in predicting economic trends and exhibits a high correlation with Treasury yields.
This also implies that over the next 6 to 12 months, there is a high likelihood of a significant downward movement in Treasury yields.
This aligns with the market’s interpretation of the monetary policy cycle. In the second half of 2023, with easing price pressures and a cooling job market, the dovish sentiment at the Federal Reserve has been intensifying. Even Christopher Waller, a previously hawkish figure at the Fed, has abandoned his stance on interest rate hikes.
Just a few weeks ago, the Fed decided to maintain the interest rate in the range of 5.25%-5.50%, and Fed Chairman Powell subsequently admitted that the timing of rate cuts would become a matter the Fed “needs to consider going forward,” prompting a decline in bond yields. The market has also started to predict that the earliest rate cut could begin as early as March this year.
