What Commodities Are Telling Us about Bonds

Global interest rates are plunging as investors brace for a worldwide slowdown. Over the past month, the yield on the benchmark 10-year Treasury note slid 0.6 per cent to 1.46 per cent, with most of the drop occurring over the last three weeks. This morning, the US 30-year Treasury bond yield dipped below 2 per cent for the first time ever. As we have pointed out in the past, more than $14 trillion of bonds worldwide carry negative yields: the French, German and Japanese 10-year notes all offer negative yields, while the Swiss 10-year note currently trades at negative 1.1 per cent.

We believe US interest rates have fallen too far, too fast relative to actual economic conditions. One of the most reliable indicators of global growth comes not from the bond market, but from the commodity pits: the relationship between the prices of copper and gold. Copper is a real-time barometer of economic activity because it is an industrial commodity used in construction (43 per cent of total use), electrical and electronics products (19 per cent), transportation equipment (19 per cent), consumer products (12 per cent), and machinery (7 per cent). Gold, by contrast, has limited industrial uses and is instead simply a safe-haven store of value.

Cresset addressed this theme in our June 19, 2019 note “Interest Rates Taking Directional Cues from Commodities”, and it bears revisiting. Statistically speaking, the variation in the gold/copper relationship since the end of Q1/19 explains nearly 97 per cent of the variation in the benchmark Treasury yield.  That regression implies the 10-year Treasury yield should be 1.6 per cent, not the current 1.46 per cent.  While 0.14 per cent doesn’t sound significant, it in fact represents a 1.2 per cent price decline in the underlying note.

We maintain our view that the US is not on the brink of recession. We will continue to monitor the copper/gold pair for clues to relative interest rates and health of the economy.