Copper/Gold Ratio Trading Strategy- Backtest, Performance, Statistics
The Copper/Gold ratio trading strategy seems to offer good entry points for both copper and gold. We backtest the ratio and find positive results for the next one to 12 months after a signal is triggered.
Copper and gold are two of the world’s most known and traded commodities, and both are frequently mentioned when inflation and the economy are discussed. Gold is linked to inflation, while copper is linked to the overall economy.
Let’s dive in and explain the trading strategy, backtest, and results. At the end of the article, we show you the complete Python code we used to do the backtest.
What is the Copper/Gold Ratio?
The Copper/Gold ratio is simply the price of copper divided by the price of gold.
What is the relationship between copper and gold?
The relationship between copper and gold is weak or low, but they both tend to move together. When the copper price goes up, it might put pressure on the inflation rate and interest rates, while gold might go up at the same time because of the same factors.
Copper is a key industrial metal that is used in a wide range of products we use on a daily basis, for example, building construction and electronics. The copper price goes up when the economy is hot, and is therefore used as a barometer of economic activity. When the activity is high, inflation has historically picked up. We also need to mention that the copper price is far more volatile than the gold price.
When the price of gold goes up, it’s because inflation expectations go up. Gold tends to go up when geopolitical tensions increase, as well.
Why is the Copper/Gold ratio important for traders?
The Copper/Gold Ratio is important for traders because copper is an indication of industrial activity and demand, while gold is a safe haven asset with almost no industrial use.
Thus, it compares industrial demand and the price of a safe haven asset that is very sensitive to inflation and interest rates. Financial pundits mention the Copper/Gold ratio as a leading indicator for US Treasury yields, and research we have perused seems to confirm that view.
However, we are not going to backtest Treasury yields but to find out if we can time when to buy copper and gold.
Copper/Gold Ratio Trading Strategy – Explanation
Why should the Copper/Ratio work as a timing indicator for copper and gold?
Copper is sensitive to changes in global economic activity, while gold is often considered a safe-haven asset in times of economic uncertainty. Thus, when copper falls too much, like in 2008, the signal is triggered.
Copper/Gold Ratio Trading Strategy – Backtest
A trading strategy needs to have specific trading rules, and we make the following trading rules:
- The signal is triggered when the Copper/Gold ratio is less than 0.19 for the first time in 1 year.
Here is the historical chart of the copper price and the respective buy signals from the copper/gold ratio trading rule (from year 2000 until today):
As you can see, it seems like the signal generates very good entry points. The following table shows the performance ranging from one month to twelve months after the buy signal was triggered:
The average return is positive for all periods. Moreover, the signal was very strong and generated large returns at all times except in 2019, where it rose only 2.2% after 12 months.
And what about gold?
We use the same buy signal for the gold price. Below is the historical gold chart and buy signals from year 2000 until today:
the first impression is that the returns are good, but they are not as good as for copper. Here is the table showing the returns for gold for one month up until 12 months after the buy signal was triggered:
The returns are positive and impressive, although not as good as copper.
Copper/Gold Ratio Trading Strategy – Conclusion
To sum up, today we showed you a signal with very strong predictive power about the future performance of copper and gold. Although it wasn’t triggered many times, the times it did proved to be very powerful.
Copper/Gold Ratio Trading Strategy – Python code
For your convenience, we provide you the complete Python code for the Copper/Gold Ratio trading strategy backtest: