CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 81.40% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Scan to Download iOS&Android APP

Copper/gold ratio: Is it the best indicator for value stocks?

16:53, 7 April 2022

Share this article
Tags
In this article:

What You Need to Know

The week ahead update on major market events in your inbox every week. Subscribe
Golden bull to symbolize stock growth
The copper-to-gold ratio tends to rise as increasing industrial production stimulates copper demand – Photo: Shutterstock

The copper-to-gold ratio can offer a viable compass for investing in so-called value stocks, or companies that appear undervalued on the market.

Traditionally used to gauge the health of the business cycle, the copper-gold ratio reflects the relative strength of copper, an industrial metal associated with economic expansion, against gold, a precious metal that appreciates during periods of economic instability.

During the expansion phase of an economic cycle, the copper-to-gold ratio tends to rise as increasing industrial production stimulates the demand for copper. In contrast, during a downturn, gold tends to outperform, lowering the copper/gold ratio. As the chart below shows, the copper-gold ratio is highly correlated with the confidence index of US businesses.

It is not surprising this indicator shows a very tight correlation with the performance of value stocks, or companies trading at "discount" prices relative to their fundamentals and which tend to outperform during times of economic expansions.

What is the copper/gold ratio currently telling us about the health of the economy and the behaviour of value stocks?

What is your sentiment on AMCX?

22.01
Bullish
or
Bearish
Vote to see Traders sentiment!

Together: Copper to Gold ratio and US business confidence index 

a chart showing copper gold ratio and US business confidenceCopper-to-gold ratio and US business confidence index – Credit: Capital.com / Source: Tradingview

Copper/gold ratio explained

The ratio between copper and gold measures the number of ounces of gold that can be bought with a pound of copper.

Copper is an industrial metal widely used in manufacturing and machinery production. It also has numerous applications in new and emerging green technologies, such as solar cells and electric vehicles.

The world's largest consumer of copper is China, covering about half of global demand. Therefore, China's industrial expansion is one of the main drivers for copper demand.

Gold is a precious metal used in the jewellery industry, technology and for investment purposes by central banks and individual investors. Traditionally considered the ultimate safe haven asset, demand for gold tends to increase in times of economic uncertainty or elevated inflation.

The copper-gold ratio is a reliable barometer that measures the relative strength of industrial activity against fears of economic recession or inflation.

Economic expansion typically increases the copper/gold ratio as industries invest and increase production because of confidence that household demand and consumption will grow.

In contrast, declines in the copper-gold ratio are often linked to a downturn in the business cycle and slowing production, or to an excessive overheating of the economy due to “bad” inflation, which has a negative impact on industrial activity.

What are value stocks?

Companies that trade at a discount to their intrinsic value are commonly known as value stocks.

NVDA

130.39 Price
-1.150% 1D Chg, %
Long position overnight fee -0.0064%
Short position overnight fee -0.0059%
Overnight fee time 21:00 (UTC)
Spread 0.20

AAPL

144.81 Price
-0.730% 1D Chg, %
Long position overnight fee -0.0064%
Short position overnight fee -0.0059%
Overnight fee time 21:00 (UTC)
Spread 0.07

TSLA

245.63 Price
-1.080% 1D Chg, %
Long position overnight fee -0.0308%
Short position overnight fee -0.0137%
Overnight fee time 21:00 (UTC)
Spread 0.17

AMZN

120.00 Price
-0.890% 1D Chg, %
Long position overnight fee -0.0064%
Short position overnight fee -0.0059%
Overnight fee time 21:00 (UTC)
Spread 0.21

If you're unfamiliar with these types of stocks, you've almost certainly heard of billionaire Warren Buffett, one of the most successful investors in history, who has extensively used value investing to build wealth.

Value stocks belong to industries with stable growth rates or with some pessimism about future growth considering their favourable present valuations. Companies in the energy, industrial, finance, or materials sectors are typical examples.

Investors frequently use valuation metrics such as the price to earnings (P/E) ratio, to determine if a stock is undervalued or overvalued. This ratio is calculated by dividing the company's share price by its earnings. A low P/E ratio is one of the criteria that suggests that a stock is currently "on sale" or has appealing market prices.

During periods of economic expansion, value stocks tend to outperform, particularly in the early phases of the boom cycle, when rising demand and production boost enterprises that had been mostly ignored by the market.

Value stocks differ considerably from growth stocks, such as technology companies, which have high or expensive market valuations because investors assume, and hence discount, that these firms will continue to expand their earnings at similar rates in the future.

The Vanguard Value ETF (VTV) is an exchange traded fund that reflects an index of large cap value companies, including Warren Buffett's Berkshire Hathaway (BRKb), financial firm JPMorgan Chase (JPM), health care company Johnson & Johnson (JNJ), health insurer UnitedHealth Group Inc (UNH), and consumer products maker Procter & Gamble (PG).

The iShares Russell 2000 Value ETF (IWM) is instead a representation of US small-cap value companies, including cinema operator AMC Entertainment (AMC), car renter Avis Budget Group (CAR), department store chain Macys (M), and oil and natural gas company Antero Resources (AR).

Copper/gold ratio and correlation with value stocks

correlation between copper/gold ratio and value stocksValue stocks and their tight correlation with copper-to-gold ratio – Credit: Capital.com / Source: Tradingview

What the copper/gold ratio says and what to expect next

After nearly doubling in value between August 2020 and October 2021, coinciding with the extraordinary acceleration of the post-Covid-19 global economic recovery, the copper-gold ratio has stayed virtually steady in the first quarter of 2022.

As a result, gold has ceased to underperform copper in recent months, mirroring investors' growing worries about the sustainability of the present economic recovery cycle.

Growing inflationary pressures, geopolitical fears around the war between Russia and Ukraine as well as a fresh wave of Covid-19 in China, have been the major drivers affecting the recent price action in gold and copper.

If the economic cycle continues to deteriorate, the copper/gold ratio may decline from here, bringing the performance of value stocks down with it.

On the other hand, if the conflict in Ukraine and inflationary pressures are resolved, the global economic recovery will move forward, without the brakes to stop the copper/gold ratio from growing.

Chart: Copper/gold ratio and economic cycles 

a chart showing the copper gold ratio and the expansionary/contractionary cycleHow the copper-to-gold ratio performed during the latest economic cycles – Credit: Capital.com / Source: Tradingview

Read more...

What You Need to Know

The week ahead update on major market events in your inbox every week. Subscribe
The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
Capital Com is an execution-only service provider. The material provided on this website is for information purposes only and should not be understood as an investment advice. Any opinion that may be provided on this page does not constitute a recommendation by Capital Com or its agents. We do not make any representations or warranty on the accuracy or completeness of the information that is provided on this page. If you rely on the information on this page then you do so entirely on your own risk.

Still looking for a broker you can trust?

Join the 450.000+ traders worldwide that chose to trade with Capital.com

1. Create & verify your account 2. Make your first deposit 3. You’re all set. Start trading