Dr.Copper Needs To Go Back To School

Comparing different time series to spot divergences (and thus investment opportunities) is a staple of macro trading; but as Bloomberg's Cameron 'macroman' Crise explains, implicit in the use of the technique, of course, is confidence in one’s ability to know which variables are independent and which are dependent.

An example of such an overlay is a comparison of the U.S. 10-year yield and the copper/gold ratio. Based on the relationship of the last few months, it looks like yields should be about 20 bps lower.

Intuitively, this makes sense. Not only does copper reflect input costs and thus inflation, but it is also a famously accurate indicator of the economic cycle — hence the sobriquet “Dr. Copper.”

The problem is – as Crise details below – in these days of rampant commodity speculation in China, however, can we really trust copper to give us an accurate read on the U.S. economic cycle?

I looked at monthly changes in copper and the Chicago Fed National Activity Indicator 3-month average, a useful proxy for economic activity. While historically there has been a positive correlation between the two series, over the last year and a half or so it has actually been negative.

The relationship looks the same when comparing copper to quarterly GDP growth. Historically there has been a positive correlation; more recently, however, it has turned a little negative.

While it seems likely that price action in industrial commodities is telling us something, it doesn’t appear to have much to do with the U.S. economic cycle. As such, trading bonds based on divergences with the copper price would appear to be a dubious proposition.

Perhaps Dr. Copper needs to go back to school and defend his PhD thesis to the market?

Although it does seem that Dr.Copper has caught the same 'animal spirits' hope-hype that the market has…


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