Gold and Copper Both Look Like Solid Assets Right Now

(Reuters) – It seems incongruous that gold and copper can be both rallying at the same time.

Gold reached a new record high just below $1,600 an ounce on Monday as investors sought a safe haven from the European debt crisis and worries the U.S. government may default amid the failure of squabbling politicians to agree on how to cut the deficit.

Copper is up about 14 percent since its low this year of $8,504.50 a tonne reached in May and is getting within shouting distance of its record high of $10,190, reached in February.

Basically, buying gold is a bet that the world economy is pretty much stuffed and the debt/deficit problems in Europe and the United States won’t be solved any time soon.

Buying copper is a bet that China’s economy will achieve a soft landing and continue to expand, driving demand for base metals.

Can both views be right?

On the surface, the answer has to be no. At some point either Europe and the U.S. will sort of out their problems, lifting the cloud over the economies, or they won’t and the world will tip back into a recession that even China will feel.

If Europe and the United States can resolve their problems to the market’s satisfaction, a key leg of the bullish gold story is removed.

Taking away safe haven demand doesn’t necessarily mean gold will lose its lustre, but it does mean any price gains will be more dependent on demand from central banks and for jewellery fabrication.

In this scenario it’s hard to see gold making strong gains above its current level, although valuing the precious metal has always been a little tricky.

Gold is currently still well below its inflation-adjusted peak of around $2,400 an ounce, according to Capital Economics.

This was reached on January 18, 1980, at the height of the U.S.-Iran hostage crisis, Russia’s invasion of Afghanistan and a slump in output from then top producer South Africa.

There’s no slump in gold output currently, in fact most forecasts focus on higher production next year.

However, there are heightened geopolitical tensions, ironically involving Iran again, this time over its nuclear programme, and of course the United States is now the invader in Afghanistan.

Capital Economics also produces some correlations on gold, pointing out that the precious metal averages 16 times the price of a barrel of Brent crude, but the current ratio is 13.5.

Gold would be $1,870 an ounce if it was priced according to its long-run Brent ratio.

But gold is slightly overpriced against equities, Capital Economics says, with the long-run average of the Dow Jones Index to gold being 10, but the current ratio is only 8.

Turning to copper and there is of course more to the current price than just expectations of Chinese demand.

The industrial metal is vulnerable to supply disruptions, as shown by the recent strike at Freeport McMoRan’s Grasberg mine in Indonesia, and rain disruptions in Chile, the world’s biggest exporter.

While worries over supplies certainly help place a floor under the copper price, it is the expected seasonal second-half demand from China that is driving bullish expectations.

The forecast is that the Chinese will once again turn to imports, having destocked inventories during the first half of the year, as construction and industrial activity ramps up.

An early indicator of this was June imports rose 280,000 tonnes, up 9.9 percent from the year-earlier month.

Whether this is continued will be seen from what happens to stocks held in warehouses linked to the London Metal Exchange, especially those in South Korea, from where China typically draws supplies.

It seems there are fairly solid reasons to be both bullish gold and copper, at least for now.

A graph of gold’s correlation to copper since 2005 shows while both can rise at the same time, copper normally outperforms gold unless there is a crisis of sorts.

They decoupled quite markedly in the second half of 2008 and the first half of 2009 as the global recession struck.

And in the good economic times of 2006 and 2007 copper did better than gold.

The current correlation is starting to weaken, but it’s too early to tell whether this is because the world is heading for a repeat of 2008 or whether growth is about to accelerate.

(Editing by Ed Lane)

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: