The gold-to-copper ratio represents an important barometer of global growth and historically tends to correlate well with bond yields (see the chart below). Gold is a precious metal and widely seen as a store of value, whereas copper is an industrial metal with consumption increasing during periods of economic expansion. In other words, when the gold-to-copper ratio is rising, the macroeconomic backdrop typically tends to be deteriorating, adding to downward pressures on rates.
In contrast, when this ratio is declining, the economic environment historically tends to be improving, acting as a tailwind to rates. As illustrated below, gold prices now appear to be strengthening against copper with the gold-to-copper ratio trading at key resistance levels and signaling that global economic momentum may be peaking. In our view, investors should pay close attention to near-term developments in this ratio as this might provide valuable insights on the future direction of interest rates.
The recent rollover in economic data surprise indices also goes in line with economic momentum potentially peaking. Economic momentum remains strong but a coming moderation with more data releases missing increasingly optimistic economists’ estimates may eventually weigh on market-based inflation expectations and add to downward pressures on rates (see the chart below). The large drop in the ISM New Orders-to-Inventory Components ratio in February to a new low since August 2017 also adds to the growing list of indicators suggesting that growth momentum may be peaking. Moreover, the recent weakness in U.S. and Canadian housing data might represent a sign that the sharp increase in borrowing rates may have finally started to negatively impact the real economy, possibly adding to downward pressures on yields.
In addition, another technical indicator suggesting that rates may face strong headwinds in the near-term is the recent topping pattern in the relative performance of financial stocks against utilities. As illustrated below, the sharp rise in yields since the beginning of 2018 was preceded by a powerful rotation from Utilities to Financials. Interestingly, Financials have stopped outperforming Utilities over the past few weeks. This weakening relative performance in Financials typically occurs when the market is anticipating rates to decline as high dividend yielders such as Utilities then appear relatively more attractive.
The bottom line is that the indicators mentioned above all appear to be signaling that the rate shock may moderate in the near-term. The selloff in government bonds may now face significant headwinds, especially that equities now appear vulnerable to higher real yields with the recent sharp drop in equity / real bond yield correlations (see the chart below). Obviously higher government bond issuance may still add to upward pressures on rates but the global savings glut, technological changes and aging workforce with older workers typically adopting a more defensive investment strategy should continue to contain future increases in rates.
