The price of copper has long been a bellwether for economic conditions. The price is strongly correlated to economic activity, industrial production and economic growth in general. It is also highly correlated with the Canadian dollar and economy. The red metal’s price is reaching multi-year highs, prompting the Chinese government to sell some of its metal reserves, along with those of other industrial metals. At the same time, gold and silver prices, while not far off their multi-year highs of last year, are not escalating as dramatically; indeed, they are locked in a trading range. Looking at this, it seems to contradict the tale copper appears to be telling. Yet appearances are not the whole story.
Copper production is entirely consumed, along with some scrap metal that is recycled, in machinery, electrical and electronic goods and in the wiring in building construction and, thus, effectively sequestered in place; whereas gold production is added to the existing outstanding holdings of investors, speculators, traders, central banks and other collectors and hoarders. Financial use dominates silver, although a lot of it is also used in industrial goods, including many ‘new economy’ products such as solar panels.
Keeping money tied up in physical assets such as gold and silver becomes more expensive in ‘opportunity costs’ as interest rates rise, because the precious metals pay no interest or dividends, whereas stocks and bonds do. It is even worse than that, as secure storage is normally required for appreciable quantities of bullion, as physical coins and bars are called, which costs money. The tepid price activity of gold and silver this year is likely indicating that investors and speculators are wary that interest rates may rise from currently artificially low levels; ‘financial suppression,’ as in World War II.
Central banks are buying long-maturity bonds, which are being issued in huge pandemic-induced amounts. Buying bonds raises their prices, depressing the yield on those bonds over what they would otherwise be, effectively lowering interest rates. However, improving economic growth and some signs of abnormally high inflation are causing those same central banks, such as the Bank of Canada and the U.S. Federal Reserve Board, to give early warning that the bond purchases will not continue indefinitely and may end sooner than was originally planned when the pandemic was at its worst. Perhaps what is worrying investors is that the bond purchases are already ‘tapering,’ meaning that the other participants in the bond market will have to buy government paper and may demand higher rates to do so.
Simultaneously, budget proposals in Canada, the U.S., the U.K. and elsewhere show that political leaders are not yet reining in spending, which is still near record levels as a proportion of Gross Domestic Product. When this much spending is ‘monetized,’ i.e., paid for by central banks issuing currency to buy the bonds that are financing spending, if the economy is not depressed —and it no longer is, currently—it flows into the economy to buy goods and services, bidding up their prices. If less and less of that spending will be financed by central banks, then it must be paid for by bond investors.
When there is a greater supply of bonds than is normally ‘absorbed’ by investors, they must become significantly more attractive to attract buyers; i.e., the yield, the interest rate on offer, must rise smartly. A scare on that front earlier this year caused a sharp, temporary drop in bond prices and the stock market. If yields rise, whether or not inflation rises further, gold will look less attractive. Investors may already be expecting that, so inflows into the gold market slowed, but they have recovered of late.
Another significant factor in the stalled rise in gold is that it is a substantial by-product of copper production. As the new, apparently, sustainably higher copper price has incented mining firms to produce more copper and bring into production previously uncommercial or undeveloped ore deposits, thus gold will also be produced, adding to supply, so dampening future price rises. This will take some time to manifest itself, but it could be weighing on investors’, speculative buyers’ and traders’ minds.
Hence, the lacklustre gold action could actually be a confirmation of investors’ fears: rising probabilities of higher interest rates and more gold coming onto the market. The copper price could be signalling higher economic growth and industrial production, but gold may be telling a less happy yarn.
Ian Madsen is a senior policy analyst at the Frontier Centre for Public Policy.
Photo by Ra Dragon on Unsplash.