The State of the Economy (in One Simple Chart)
In terms of market analysis, I’m a big fan of the “KISS” method.
Also known as “Keep It Simple, Stupid.”
The truth is scouring an endless stream of economic data points isn’t always the most efficient use of time.
Instead, I opt for indicators that give me a feel for the market and then direct me toward what needs further analysis.
A perfect example of this principle at work is the gold-to-copper ratio – an indicator that serves as a reliable gauge of global economic health.
Both gold and copper are excellent proxies for market sentiment. But together they offer a unique insight into the current state of the economy.
The ratio tracks how many pounds of copper can be bought per ounce of gold.
The more copper that can be bought with an ounce of gold, the higher the ratio. The less copper that can be bought, the lower the ratio.
Now, check out the gold-to-copper ratio over the last five years…
Reading the chart is simple: A rising trend shows a weakening economy, while a falling trend shows a strengthening economy.
Based on the above chart, the gold-to-copper ratio has been dropping steadily since mid-2016 – a simple yet reliable sign of a strengthening global economy.
In fact, the annual growth in U.S. GDP since 2016 reflects the same trend…
Coincidence? I think not.
But why is this simple indicator so useful?
The Prophet of Doom and Gloom
As gold is a safe-haven asset, investors love the metal when markets are turbulent and pessimism runs high. But often gold loses its appeal when markets are euphoric and stocks are red-hot.
It’s why I think of gold as a “doom and gloom” indicator. It goes up on fear and down on contentment.
Now, gold prices haven’t done a heck of a lot since putting in a bottom in late 2015…
Since then, gold has gained 30% (before dropping off again) and has yet to top its mid-2016 high.
Gold’s price action suggests that investors aren’t too worried or fearful. In fact, market sentiment is oddly balanced.
According to the most recent AAII Investor Sentiment Survey, about 34% of investors are bullish on stocks over the next six months.
Another 31% are neutral… and the remaining 35% are bearish.
In other words, investors are far from euphoric or panicky – which is exactly what gold prices are confirming right now.
The Market’s Industrial Health Tracker
Copper is used heavily in many sectors of the industrial economy. It’s found in everything from TVs, computers, cars and wristwatches to houses, bridges and roads.
As a result, the demand for copper – and other base metals – reflects whether an economy is growing or slowing.
As industrial demand for copper rises, prices also rise. And that tends to signal a strengthening economy.
But when demand drops, prices slump. That signals a weakening economy.
Since copper’s low at the start of 2016, prices surged 69% before dropping back down this year. (Though the price is still up 41% from its low.)
As we can see, copper’s outperformance over gold signals a positive outlook on economic growth. And it’s why the gold-to-copper ratio provides such a great snapshot of the state of the economy.