Finally, Something Worth Buying!

Finally, Something Worth Buying!
Reda Farran, CFA

over 1 year ago3 mins

  • The copper-gold index – the ratio of copper’s price to gold’s – is a good gauge of global economic sentiment and also serves as a leading indicator of the 10-year Treasury yield.

  • The index and the 10-year yield have significantly diverged this year. In the past, gaps this wide were usually accompanied by yields following the index lower.

  • That – along with a number of other factors – is a positive sign for Treasury bonds, which you can invest in using the iShares 7-10 Year Treasury Bond ETF.

The copper-gold index – the ratio of copper’s price to gold’s – is a good gauge of global economic sentiment and also serves as a leading indicator of the 10-year Treasury yield.

The index and the 10-year yield have significantly diverged this year. In the past, gaps this wide were usually accompanied by yields following the index lower.

That – along with a number of other factors – is a positive sign for Treasury bonds, which you can invest in using the iShares 7-10 Year Treasury Bond ETF.

Markets across the board have been slumping, and odds are you’ve been looking high and low to find any hint of a return. Well, the wait is over: one indicator is now flashing a screaming buy signal for longer-term US bonds.

What is the indicator?

It’s the copper-gold index, which is the ratio of copper’s price to gold’s, and it’s historically been a good off-the-beaten-path gauge of global economic sentiment. See, the two metals have two very distinct roles – copper as an industrial mainstay and gold as a safe-haven asset. And their market prices – especially in relation to each other – tell us a lot about what’s happening in the economy.

Copper’s demand (and therefore its price) is strongest in times of global economic growth. Gold, meanwhile, sees higher demand (and higher prices) during times of economic uncertainty. So, the copper-gold index functions as an indicator of the market’s appetite for risk assets – like commodities or stocks – when the economy is growing versus safe-haven assets – like gold or government bonds – during times of uncertainty.

Historically, the index has also served as a leading indicator of the 10-year Treasury yield. The index’s absolute level is irrelevant. What matters here is its direction – and whether the 10-year Treasury yield has moved in the same direction or has diverged. In past episodes of divergence, the 10-year yield has eventually tended to follow the copper-gold index.

The copper-gold index and 10-year Treasury yield have historically tended to move in lockstep. Source: scottgrannis.blogspot.com
The copper-gold index and 10-year Treasury yield have historically tended to move in lockstep. Source: scottgrannis.blogspot.com

What’s the copper-gold index saying today?

The index had been gradually drifting lower for much of the year, reflecting concerns (rightfully so) about global economic growth. But in the past week, the slide picked up speed, pushing the index to its lowest level since February 2021 (here’s a good online tool to track the index). The 10-year Treasury yield, meanwhile, has virtually doubled this year. You can clearly see the big divergence between the two measures in the graph below.

The copper-gold index and 10-year Treasury yield have significantly diverged this year. Source: Bloomberg
The copper-gold index and 10-year Treasury yield have significantly diverged this year. Source: Bloomberg

Now, admittedly, growth expectations are falling largely because of rising interest rates, which naturally also lead to higher bond yields. And so it’s not entirely shocking that, in this market environment, bond yields have gone up while the copper-gold index has swung in the direction of economic uncertainty.

But judging by the graph, the divergence is now a little extreme. And in the past, when the gap between the two has grown this wide, the two eventually converged – usually with the 10-year yield following the copper-gold index lower. And that means Treasury prices have risen during those times (since they move inversely to yields).

What’s the opportunity here?

As Stéphane explained about a month ago, bonds are currently the world’s most hated asset. So looking at them again means you’re probably onto an interesting contrarian trade – one that’s looking even more interesting under the lens of the copper-gold index. Higher yields will eventually drive higher bond demand. In the meantime, any positive surprises regarding either interest rates or inflation could lead bond prices to recover sharply.

Finally, recession risk may soon outweigh inflation risk. That’s because the Fed is actively trying to slow growth to reduce inflation. And if history is anything to go by, it’ll overshoot the mark: the Fed has only once managed to achieve a “soft landing” – raising interest rates without tipping the economy into a recession. And the Fed chair doesn’t sound too confident this time around: this week he called a soft landing “very challenging”. If the Fed finds itself confronted with a US economy in recession, it won’t have much choice but to start slashing interest rates again.

The iShares 7-10 Year Treasury Bond ETF (ticker: IEF, expense ratio: 0.15%) is a solid option if you’re looking to buy bonds. Remember, you don’t need to buy in all at once: entering gradually over time – as prices fall – might be a great way of smoothing your entry point.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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