Using The Metal Markets to Forecast The Direction of Interest Rates

In a recent podcast interview with Tim Ferriss, Adam Robinson mentioned an interesting observation about interest rates. Adam is the co-founder of The Princeton Review, a chess master and  an advisor to several hedge funds and investment managers.

Adam mentioned that one of the tools he uses to evaluate the fixed income market is the relationship between copper and gold. With a very high correlation to the 10-year Treasury yield, when the ratio between these two metals is rising, often are interest rates. The chart below shows the current 90-day correl is 0.98.

Knowing that the ratio between copper and gold is highly correlated to interest rates, we can apply a degree of analysis to gold and copper and make a forecast for where the ratio may be headed and thus, the direction interest rates may be moving.

One method we can use is looking at the Commitment of Traders data. Below is the COT report for gold. In the bottom panel we can see the three category breakdown of each trader group. The Commercial trader (often considered the ‘smart money’ has been working off their large net-short position in gold, which hit its largest point in June when gold put in a short-term high. Since then, Commercial traders have been moving their net-position to near neutral, a positive sign for gold bulls.

Turning our focus to copper, the COT report shows us that the Commercial traders have been betting against copper, holding one of their largest net-short positions.

So from these two data sets we know that Commercial traders appear to be becoming more bullish on gold and are bearish on copper. That would imply that the ratio of copper vs. gold could be heading lower, and in turn interest rates declining as well.

This is all good but how are traders position in the actual bond market? we can look at COT data to evaluate the fixed income market. Below is the COT report for the 10-year Treasury Bond. We can see that Commercial traders have been adding to their net-long position in the 10-yr bond, putting their position at one of the most bullish levels in quite a while.

In summary, as Adam pointed out, copper and gold have a high correlation to interest rates, and based on the COT data it appears we could be seeing a shift lower in the ratio between these to metals, a bearish move for Treasury yield. Based on the COT chart for bonds themselves, it appears the ‘smart money’ is using both hands to buy up this dip in bond prices.

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