Wednesday, May 18, 2011

SPG Supplement: Is the Gold/Copper Ratio Predicting A Drop In the S&P?

To give my regular readers a taste of what’s on my Strategic Planning Group site, here's this week’s Supplement—though a few days after SPG members got it:

People are always talking about the silver/gold ratio—but the copper/gold ratio seems to be much more predictive of market trends.

My friend Michael Hampton has this very interesting chart—check it out:

The top chart is a ratio of copper-to-gold prices. The bottom chart is of the S&P index. If you notice the timeline, you’ll see the chart covers the last three years.

The red circle 1 is when the copper/gold ratio turned down—followed shortly by a turn down in the S&P index which [sarcasm alert] we all have such fond memories of. The subsequent green circle in the ratio—the bottom of the ratio—came shortly before the uptick in the S&P from its bottom of 666.37.

Similarly, red circle 2—the downturn in the copper/gold ratio—signaled the top of the market in the S&P. However, the subsequent green circle anticipated the bottom of the S&P by about six weeks.

Now, at red circle 3, there is a clear break down in the ratio.

Does this signal a break down in the S&P?

Michael seems to think so—and so do I. From the ratio, one could make the reasonable claim that equities are set to take a tumble in the near-term: Say within the next couple of weeks. How severe a tumble? Between 7% and 10% seems reasonable, within a three-week period. Furthermore, it would make sense for the equities markets to turn severely bearish, now that Quantitative Easing-2 (QE-2) is supposed to end. The lack of Federal Reserve-supplied liquidity will definitely squeeze all asset classes—not just commodities.

So expect the S&P to break down between now and the first of June at the latest—and from this break down, expect the Federal Reserve to become more aggressive in its talk about extending QE-2 into QE-∞. Individual FOMC board members are already making noises about extending QE-2, as are some prominent investment bank economists, especially at Goldman Sachs. A jolt down in the equities markets would put further pressure on the Fed to just keep on printin’.

Stay tuned for updates.
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  1. Think it might be quite risky to use one commodities-based indicator to predict movement on the main stock markets. It might be helpful, but it's a risk to use it as a forward indicator for market timing. If you do decide to do this, make sure you check the correlation over several decades.

    Looking at the value of copper in terms of the gold price is really just looking a the true price of copper using a fixed currency (gold being the only true currency that is not being depreciated).


  2. We are soon coming to an end of this counter-trend cyclical bull market rally within a secular bear market. Nothing abnormal about it. This current rally was fake to begin with, driven by the Federal Reserve. Buy gold and silver.

  3. @Morgan Silver Dollars - I have heard that before too many time and we havent crashed yet. When??

  4. They don't call it "Dr. Copper" for nothing. It knows stuff.

  5. Looks like we're in the process of rolling right off the cliff. Just wait till 2nd quarter earnings come out. All electronics companies/ car manufacturing, and any other industries remotely related to the Japanese economy will be in free-fall. So much for The Bernank's plans to run QE3 behind the scenes...he's gonna need $1-$2 Trillion MINIMUM now!

  6. I am of the opinion that we will see a significant economic downturn with copper leading the way. This is why I have bet against copper.

  7. we will have a slowdown, not an apocalyptic drop, in gdp this year. there is nothing to indicate more than malaise going on in our economy since the drop in 2008. no data has improved dramatically, and no data has dropped dramatically. this malaise may last another 3 to 5 years. but thats all it is, malaise. people bracing themselves tightly for the end of our economy will wind up with numb arms.

  8. Looking to me like the ratio has reached a low and might bounce here.

  9. I just checked the compare charts of SPY:$COPPER, and found some correlations, but the ratio range is wide, and how can we make use of this correlation? Maybe we can use Copper to hedge our stock portfolio.


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