Are markets right to be quite so upbeat?

Chart of the week

Looking at the divergence between the copper/gold ratio and real yields suggests that some caution may be in order.

All in all, 2021 has been going pretty well so far in financial markets. Sentiment remains upbeat and many stock indices have reached new record levels. The oil price has also risen sharply since the days in April 2020 when black gold was trading at negative prices.

One indicator that reflects how markets view economic prospects at a given point in time is the relationship between the price of copper and the price of gold. Copper is an important industrial metal for which demand is closely correlated with economic activity. Gold, on the other hand, is often considered a popular safe haven for investors, especially during uncertain times.

As can be seen from our Chart of the Week, over long periods there has also been a good correlation between the copper/gold ratio and real yields. According to the textbooks, the latter tend to reflect the real growth expectations of the bond market. Which makes it all the more interesting that we can currently observe an unusual divergence. While commodities, like many other asset classes, point to a continuing recovery, real yields on both sides of the Atlantic remain at record low levels. One might suspect that this is mainly due to central-bank policy. A comparable gap existed in the past decade during the phase between 2012 and 2013, when the U.S. Federal Reserve (Fed) also bolstered the economy with bond purchases.

In 2013, this phase of divergence between commodity markets and government-bond yields came to an abrupt end when the Fed announced that it would begin to phase out its bond-buying program. In fact, the gradual winding down of the purchase program did not take place until 2014, but the mere announcement was enough to rattle markets. With that in mind, it is probably worth it to keep a close eye on developments on the bond market, especially in the current phase, characterized by economic optimism. Should sovereign bonds once again become an attractive alternative for investors after a rise in yields, things may become rather uncomfortable for various riskier assets.

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Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 2/11/21

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