Interpreting rises in gold and copper

All confused at Reuters...

Inflation is not even considered...

From The International Herald Tribune:

Interpreting rises in gold and copper

BY CLYDE RUSSELL | REUTERS

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

Buying gold is a bet that the world economy is in deep trouble and the debt problems in Europe and the United States will not be solved any time soon.

Buying copper is a bet that the Chinese 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 United States will sort out their problems, 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 major leg of the bullish gold story is removed.

Taking away demand for safer investments does not necessarily mean gold will lose its appeal, but it does mean any price gains will be more dependent on demand from central banks and for jewelry fabrication.

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

Gold hit a new record high just above $1,600 an ounce Monday as investors sought a haven from the European debt crisis and from worries that the U.S. government might default.

However, it is still well below its inflation-adjusted peak of about $2,400 an ounce, according to Capital Economics. That was reached Jan. 18, 1980, at the height of the U.S.-Iran hostage crisis, the Russian invasion of Afghanistan and a slump in output from what was then the top producer, South Africa.

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

However, there are heightened geopolitical tensions involving Iran again, this time over its nuclear program, and of course the United States is now the one involved in military action in Afghanistan.

Capital Economics also produces some other 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 were priced according to its long-run Brent ratio.

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

As for copper, there is of course more to the current price than just expectations of Chinese demand. Copper is up about 14 percent since its low this year of $8,504.50 a ton, reached in May, and is getting closer to its record high of $10,190, reached in February.

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

While worries over supplies certainly contribute to constraints on the price of copper, 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 depleted inventories during the first half of the year, as construction and industrial activity increases.

An early indicator of this was data showing that China's imports in June rose 280,000 tons, up 9.9 percent from the same month a year earlier.

Whether that continues will be seen in the evolution of 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 bullish on both copper and gold, at least for now. A graph of gold's correlation to copper since 2005 shows that while both can rise at the same time, copper normally outperforms gold unless there is a crisis of sorts.

The price trends of the two metals diverged 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 is too early to tell whether that is because the world is heading for a repeat of the global downturn of 2008 or whether growth is about to accelerate.

Clyde Russell is a Reuters columnist. ◼

Get the best global news and analysis direct to your device – download the IHT apps for free today!
For iPad: http://itunes.apple.com/us/app/international-herald-tribune/id404757420?mt=8
For iPhone: http://itunes.apple.com/us/app/international-herald-tribune/id404764212?mt=8

Sent from my iPad