By Richard Baker, CP Value Analytics
My Oct. 17 commentary borrowed a line from the Grateful Dead to describe the long strange trip of copper and gold in 2011. It’s difficult to imagine what song title might best describe their odyssey this year but the roadies have already set the global stage for the metallic superstars’ 2012 World Tour.
Tracking the performance of copper relative to gold can reveal and anticipate macro-economic trends. The red metal has vast industrial and power grid applications thereby qualifying it as a reliable gauge of global growth or contraction. Gold has multiple-personalities; it can behave as a commodity, an alternative to fiat currency or a safe-haven in global crises. A scatter plot of their long strange trip in 2011 is a powerful way to understand their often changing relation and provide clues to what may lie ahead for 2012.
Figure: U.S. Debt Downgrade is a Market Tipping Point,
Comex copper price is plotted versus Comex gold for the most active futures contracts last year. The red triangles represent the price pair in U.S. dollars for all the market days in 2011. The red lines connecting the data points represent their “trip” or price trajectory throughout the year. The bifurcation of their journey into two distinct price domains (circumscribed by dotted ellipses) is nothing less than “strange” when compared to more normal years that lack the drama of highly accommodative monetary policy, western economy debt crises and the erratic political reactions that result.
Aug. 5 (big red triangle) proved to be a critical tipping point for base and precious metal markets; that day credit-rating agency Standard & Poor’s downgraded U.S. debt for the first time in the nation’s history. The downgrade followed a dysfunctional U.S. debt ceiling debate amid a gravely worsening European sovereign debt crisis. This date is the single intersection of the two price domains.
“Price Domain A” within the upper-left ellipse marks a period where commodities were buoyed by a second round of U.S. Federal Reserve quantitative easing and Comex copper set an all-time high of $4.6375 a pound on Feb. 7. Gold gradually rose in U.S. dollar price over this period.
“Price Domain B” in the lower-right corner captures the post-downgrade crash in copper prices and gold’s surge to its new-record high of $1,923.7 an ounce on Sept. 6. At that time gold was in safe-haven mode and copper fled in full retreat to bear country. As the year closed the yellow metal had returned to mid-$1,500/oz territory joining copper in the bear camp.
Table 1 uses the gold-to-copper price ratio to illustrate the wild swing from copper-bullish to copper-bearish conditions for domains A and B. At the February copper high, an ounce of gold bought only 293 pounds of copper; in October an ounce could fetch as much as 538 pounds. The highest (i.e. most bearish ratio) during the 2008-2009 financial crisis was a sobering 621 pounds per ounce. In more normal markets a range of 300 lb/oz to 400 lb/oz is typical. Ratios greater than 400 lb/oz are considered “recession levels” – ironically, the ratio on Aug. 5 was 401 lb/oz.
Gold-to-Copper Ratios
The plot in Figure 2 combines the ratio data in Table 1 with the previous chart. Gold-to-copper ratios of constant value appear as straight lines whose slope is the inverse of the ratio:
Bull/Bear Constraint BoundariesPrice domain A falls between the “Cu-Bullish 2011” green line and the “Bull/Bear Threshold” dotted orange line. Price domain B is below the threshold and above the “Cu-Bearish 2011” red line. The “Cu-Bearish 2009” dark red line is included to indicate a low-price constraint boundary given the recent history of the Great Recession.
Finally, two copper and gold price predictions for 2012 are denoted by dark blue diamonds. The first is Goldman Sachs’ 2012 gold target of $1,940/oz and an average copper price of $9,000/metric ton ($4.0824/lb). The second diamond is the SEB Commodity Research estimate of $2,050/oz and $8,625/metric ton ($3.9123/pound). Expressed as gold-to-copper price ratios on the chart, these predictions are 475 lb/oz for Goldman Sachs and 524 lb/oz for SEB.
Analysis
In December, I said 2012 may prove to be an "outside" year for gold prices exceeding both the highs and lows of 2011. This would see gold near or above the $2,000/oz level on the high-side and approaching the $1,300/oz on the low-side. My high-side for gold is consistent with both the Goldman Sachs and SEB numbers and could be sparked by a conflict in the Persian Gulf.
On the low-side, continued downward revisions of global growth due to worsening conditions in the U.S., Europe and China could result in a disinflationary environment that eventually pushes gold back to low-$1,300/oz levels and copper to $2.50/lb.
The recent Federal Reserve extension of very low interest rates to late 2014 and the possibility of additional quantitative easing given Friday’s less-than-expected GDP number are now likely to prevent the low-side scenario. From Figure 2, the “Cu-Bearish 2011” line indicates a gold price floor of $1,615/oz going forward keeps copper above the key psychological level of $3/lb for the year.
On the bullish side for copper, it is unlikely that the latest monetary easing will result in the bubbly highs of 2011. There is a growing consensus that further quantitative easing by central banks will provide diminishing impetus to commodity prices. Gold and copper have started the year well with gold closing Friday at a seven-week high and copper recovering almost all the ground lost to the late September crash. However, the Friday gold-to-copper ratio at 445 lb/oz is still in bear country historically.
Although the Goldman Sachs and SEB copper estimate are averages for the year and don’t preclude red metal prices from spiking higher, the averages indicate a bias below the bull/bear threshold of 400 lb/oz. Figure 2 suggests that $4.50/lb is a likely ceiling for 2012 even with the return of moderate copper demand and growing supply constraints.
On the other hand, these two metallic superstars had plenty of surprises in their act last year; perhaps new highs for both in 1H will have the metal markets happily singing Truckin’ before the 2012 World Tour breaks for intermission.
Source: Eurekaminer.blogspot
