Data Diary

Copper/gold ratio as a leading indicator

Posted on 12 February 2010

David Rosenberg (via Traders Narrative) pointed out a contender for the next iteration of our leading index for the ASX 200 Materials sector – the copper to gold price ratio.

The thinking is that the copper price reflects the health of the industrial complex while the gold price mirrors systemic and monetary risks. Looks pretty compelling from this vantage point.

So to revisit our ruminations of a couple of weeks ago (for easy reference – here) – could this ratio become part of our XMJ leading indicator?

To tailor the concept a little more to Australian conditions, the following chart takes the RBA Base Metals US$ Price Index as a ratio to the US$ Gold Price (based on monthly averages):

Based on this slice of history looks like base metals are trading cheap relative to gold.  Okay so how does it look against our stock market.  First up a longer term view comparing the ratio to the All Ordinaries:

Looks like over the longer term, the relationship is pretty wayward.  For example. around the equities collapse of 1987 – gold peaked with equities while base metal prices continued to surge higher into June 1988.  This time the roles were reversed – with base metals prices peaking in May 2007 and gold merely pausing for a breather from Jan 1988 until quantitive easing kicked in in November 2008.

But maybe that is the point, the relationship has been reinforced by more recent events.  Consider how the ratio moved through the noughties in the context of the money creation machine that was the shadow banking system – and how that flow feed the industrialisation of China in particular.

So to even more recent history, comparing the ratio to the ASX materials sector:

Looks pretty interesting up this close.  Particularly, like the early turn in the ratio ahead of XMJ itself.  Is it a contender then?