Gold and copper – twins in rallies
• Base and precious metals correlations +0.5 since 1990. Loose monetary and loose fiscal policy reinforce co-movement.
• Financial repression & inflation take 18m gold to $3000/oz; green stimulus may push silver to sustained deficit; upside risk.
• Rebounding global demand should keep copper undersupplied
Precious and base metals rally usually simultaneously
Prices of many mined materials have rebounded, with gold, silver and copper up 29%, 37% and 6% YTD respectively. The simultaneous gains of base and precious metals has caused concerns among market participants over how fundamentally supported the rally is: gold is usually perceived as an anti-cyclical commodity, while copper tends to be viewed as linked to the strength of the business cycle. While quotations of the various mined raw materials can indeed diverge at stages, prices have trended into the same direction more than half of the time since 1990. The current macro-economic backdrop of loose monetary and loose fiscal policy reinforces that dynamic, so we believe the recent rallies can be justified.
Gold to $3000/oz, silver upside risk to $50/oz
Real rates, statistically the most significant gold price driver, have fallen steadily in recent years as nominal rates declined (see When an R* falls, gold rises). The share of negative yielding assets is increasing, suggesting market participants expect central banks to remain dovish. We agree with that, as financial repression looks to remain in full swing. Yet, with policy rates already at or even below the zero bound, support to gold prices will increasingly have to come from higher inflation, in our view. Linked to that, US authorities are over-stimulating the economy - the output gap is around 10% at present, while the stimulus announced so far is running well ahead of that. The Fed effectively backstopping the government is a key reason, we expect gold to hit $3,000/oz in the coming 18 months (see The Fed can't print gold). Some of the investor demand from investors for hard assets should also feed through into silver; notwithstanding, industrial demand ultimately matters more for the white metal. Hence, it is worth noting that fiscal spending globally is increasingly green.
This raises the likelihood that silver consumption will increase from photovoltaics. To that point, the plans of US presidential candidate Biden to make the power sector emission-free, if he is elected and these are implemented, this would push the silver market into a sustained deficit. The last time the market was undersupplied, silver rallied to $50/oz, a price move that could be possible within the next 5 years, in our view.
Copper in deficit next year
Copper and the US policy rate have traditionally been positively correlated as the Fed fine-tuned the business cycle by adjusting monetary policy. Yet, the relationship between rates and copper has broken down after the Great Financial Crisis, reinforcing that central banks have largely lost the ability to influence economic activity. Linked to that, loose monetary policy coupled with lacklustre growth pre-Covid-19 mean that the copper:gold ratio has fallen persistently. That said, fiscal stimulus has already been very successful in China, where copper demand has expanded by +20% YoY in the past couple of months. With more stimulus on the way in the US and the recovery fund in the EU kicking in from 1Q21, we believe consumption should rebound globally next year, pushing the copper market into a deficit. This should support prices in the coming quarters.