Another Look at the Copper/Oil Ratio—Or Is It the Oil/Copper Ratio?

Yesterday, we argued that by juxtaposing Leeb’s Oil Indicator, our Oil/Gold Indicator, and Klombies’s copper/oil ratio, we could make fairly accurate medium-term predictions of the oil price.

The most predictive of these tools is the copper/oil ratio, although I am only able to test this back to a period of a little more than a decade. Also, Klombies’s technique missed out on the 2009 oil spike, which had been predicted by our combined oil and gold system (i.e., our combination of Leeb’s Oil Indicator and our Oil/Gold Indicator, all of which requires a more convenient name). But, this 2009 spike was a unique situation, one we argued occurred only once before, under the virtually identical conditions of the 1970s. So, there is no reason to chuck out Klombies’s copper/oil technique, until we can get longer term data.

The question which now confronts us is, if copper tells us what oil is going to do, is there some way to predict copper?

My answer is a tentative Yes. But, we are also going to be dragged into some very sticky questions about cause and effect.

Look at the following two P&F charts. (Reminder: circumstances prevent me from providing more adequate charts). You will notice that the Dollar Index/10 year yield ratio is the inverse of the price of copper.

Again, P&F charts are not the best for intermarket comparisons, but it should nevertheless be fairly clear that the copper lows of 2002-2003 coincided with highs in the dollar/yield ratio. The tops of May 2006 and May 2007 in copper then coincided with new lows in the dollar/yield ratio in May 2006 and the summer of 2007.

This was then followed by the oil ‘shock’, which brought copper down to its December 2008 low, and which neatly coincided with a high in the dollar/yield ratio. This relationship has continued with the copper top in late 2009/early 2010–which was apparently only a brief stop provoked by oil’s virtual doubling by early 2010–and continued until the winter of this year. This spring’s commodity collapse is also reflected in the rise of the dollar/yield ratio. It will be interesting to see if the dollar/yield ratio continues to rise in the face of a technically strong copper market.

If we look at the same copper/oil ratio that we looked at yesterday, we will see that the dollar/yield ratio has a similarly inverted correlation. This suggests to me that copper and perhaps industrial metals in general have a very strong relationship with this dollar/yield ratio.

copper/oil ratio since 1999

If comparing copper/oil with dollar/yield ratios is giving you a headache, then you can compare the oil/copper ratio below with the dollar/yield ratio. It gives a slightly different perspective of time from the copper/oil ratio, as well.

oil/copper ratio

In fact, the oil/copper ratio appears to lead the dollar/yield ratio. The renewed strength in oil vis-a-vis copper that began in January and February of this year foreshadowed the rise in the dollar/yield ratio this spring, which has coincided with the economic nervousness exhibited in the stock market and reflected in the soft data of the second quarter. It remains to be seen which direction the copper/oil ratio will move in.

But, this appears to have brought us full circle in our argument. We had intended to show that the dollar/yield ratio had a strongly inverted relationship with the price of copper, but we have slid into arguing that the oil/copper ratio is driving the dollar/yield ratio. Is there a way out? And, if so, how?

The problem is that copper seems to have a very strong inverse correlation with the dollar/yield ratio, which is itself led by the oil/copper ratio. That would mean that copper is led by the copper/oil ratio. You can see from the copper and copper/oil and oil/copper charts that this is generally true (at least over the course of the last 12-13 years). But, our argument yesterday had put copper in a relatively dominant role—copper has tended to drive up strongly before taking oil up with it—but copper itself now appears to be a slave to the copper/oil ratio, as well.

I am not prepared to set aside the question of the price of copper quite yet, but it would seem as if the copper/oil ratio (or oil/copper ratio, if you prefer) insists on being dealt with first. I have a few ideas of how to approach this question in the next couple days, but I have not yet decided on which one. I believe that when we start getting to the question of bonds and the dollar, we are approaching root causes, but it might be premature to attack this question now. Stay tuned.

In the meantime, if our conjecture thus far here is sound, then the price of copper (and industrial commodities generally?) are likely to move in a fashion inverse from that of the dollar/yield ratio. And, both copper and the dollar/yield ratio are dependent upon the oil/copper ratio, which at the moment seems to be in a narrowing triangle awaiting resolution. If there were some way to predict this oil/copper ratio, then we could hone our oil forecast and say something about copper, as well as the dollar and bonds, perhaps.

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