As markets become increasingly interconnected, cross-asset price trends should not be ignored. What indicators can be used to perform Intermarket Analysis? In this post, we provide two examples:

The Copper to Gold Ratio: A Proxy for Economic Growth

The chart below depicts the Copper/Gold Ratio along with the S&P Small Cap 600 Index. At point 1, in the summer of 2018, you’ll see the Copper/Gold ratio declining substantially, signaling a potential global growth slowdown. The stress then cascaded into the equity markets, which made a sharp and fast downturn in the 4Q 2018 before a recovery began to take hold in early 2019.

The Copper/Gold ratio continued to trade lower even as equities moved mostly higher throughout 2019, a signal that all was not well. This divergence held until equities made a strong move to the downside during the COVID pandemic. At point 2, in the first two months of 2020, the ratio began a steep descent and subsequent breakdown, leading Small Caps into a period of heightened volatility.

While the correlation to Small Cap stocks has been mostly positive, the ratio shifts between leading, lagging, and coincidental. In this case, the ratio bottomed a few weeks after equities.

This ratio has been stubbornly flat and trendless for the majority of 2021 and into 2022. In that time, equities have moved off their highs but have also traded mostly sideways.

S&P 500 Low Volatility Index, the S&P 500 High Beta Index, and the U.S Dollar Index

Despite these two relationships coming from completely different asset classes, they tend to trade in sync in periods of heightened uncertainty, as investors seek havens in the form of low volatility stocks and the dollar.

However, no relationship correlates all the time, and the ratio of Low Volatility stocks to High Beta stocks and DXY provide examples of both.

On point 1 in the chart, we see the DXY breaking out in May 2018—long before fears of slowing global growth spread to other markets. The Low Volatility/High Beta ratio finally broke out in October of the same year and continued to trade closely with the DXY until markets recovered in 2019 and 2020. Here we have two “risk-off” relationships that have a history of trading closely together that we should be able to use into the future, right? Well, as we said before, markets never make it that easy for us.

The DXY sold off along with risk assets in the first part of the COVID crash as Low Volatility stocks were outperforming their riskier counterparts. Intuitively this stands against reason, as the DXY “should” be in high demand during periods of extreme uncertainty, particularly compared to other world currencies.

DXY subsequently rebounded over 6% in a matter of two weeks, a large move in that timeframe for all but the world’s most unstable currencies. It wasn’t until the summer of 2020 that the Low Vol/High Beta and DXY relationship once again became positively correlated.

This example illustrates that while Intermarket Analysis can be incredibly powerful, it can also be perilous if it’s the only form of analysis relied upon.

Recent price action has the Low Volatility/High Beta ratio moving sideways while the DXY has continued its ascent; will the DXY once again lead the ratio higher, much like that of Q2 2018? Only time will tell.

Relationships Matter

Price is king, and the markets are never wrong, but investors can certainly be wrong—it’s important to keep that in mind with any methodology we apply in capital markets.

There are many market relationships that we can use to either add or subtract from the evidence that we are seeing in the major asset classes.

What happens when they disagree? Well, that’s valuable information too.

(Bloomberg Intelligence) — Applying well-established momentum techniques to the hyper-volatile crypto asset class can improve risk-adjusted returns vs. buy-and-hold strategies, while simultaneously forewarning of major cyclical turning points. Our momentum measure turned bearish in November 2021, near the cycle peak, and has avoided the majority of the current 50% drawdown.

1. Crypto Momentum Strategies Uncommon Despite Volatility

Bitcoin proponents rightly argue that volatility is a feature, not a bug, of that asset, but hyper- volatility and regular drawdowns have kept the majority of traditional finance investors on the sidelines. Against other risk assets, Bitcoin’s volatility has been decreasing since 2018, yet it and other crypto assets remain in a class of their own with 3x the volatility of Bloomberg’s World Equity index and other risk assets. Though volatility and return moderation is expected as Bitcoin marches toward becoming a several trillion dollar store of value asset, investors may want to deploy strategies that can provide better risk/rewards entry points and lower overall volatility.

Crypto Volatility & MaxDD vs. Global Risk Assets

Source: Bloomberg Intelligence

2. Weathering Volatility With Trending Indicators

The application of moving averages in a trading strategy has two primary benefits: they smooth out shorter time frame price volatility and identify potentially significant price reversals. These strategies are also commonly used by systematic momentum investors to extract significant portions of large price movements, which make them more adept for trending markets than sideways or range-bound markets.

The deployment of three different time frame moving averages will by default provide a lagging indicator that due to its lower sensitivity should detect the most significant and robust trends for an asset. The addition of a trend slope indicator can also enhance the triple moving average signal by ensuring that a signal is only given when the gradient of the longer-term moving average is positive.

Triple Moving Average Crossover Signal

Source: Bloomberg Intelligence

3. Trend Signal Improves Risk-Adjusted Returns

Our trend signal, which combines three moving averages and a slope indicator, has identified significant trend reversals for Bitcoin, Ethereum and the Bloomberg Galaxy Crypto Index. When applied as long-only system the strategy demonstrates a meaningful improvement in risk adjusted returns in bull and bear cycles vs. a buy-and-hold strategy. Over the period from 2015 to present, when the strategy was applied to Bitcoin, it produced a Sharpe ratio of 3.81 vs. 1.31 for buy and hold. The signal was positively skewed with a 65% hit rate on the 28 occasions it was triggered. For Bitcoin the trend signal switched from bullish to bearish in November 2021, avoiding two-thirds of the current 50% drawdown. These favorable results are demonstrable for the Bloomberg Galaxy Ethereum and Crypto indexes as well.

Trend Signal Performance 2015-22

Source: Bloomberg Intelligence

Personal transformation through a trading metaphor was how Van described his life’s work. I first met Van in 2012 when I enrolled in his Peak Performance courses, travelling to Cary, North Carolina to attend in person. After reading ‘Trading Your Way To Financial Freedom’ in 2009 I became acutely aware that everything I was doing in terms of investing was essentially flawed.  Van being a trained psychologist, and trading coach for over 3 decades seemed to be an outlier in a saturated market of investing aficionados. He prioritized a strong mental framework in producing long term success in the markets.  It was Van who explained one should never trade without a system with strict rules, a teaching that motivated me to complete my CMT designation.

Most people discover Van for the first time reading Jack Schwagers masterpiece “Market Wizards: Interviews with Top Traders’. I highly recommend it if you have not read it. Read that chapter where Van lays out the concepts which would become the principles for his life work.

There are inflection points in everyone’s life that alter our perspective and even our entire trajectory. Attending Van’s course was one of those breakthrough moments for me. The two weeks I spent with Van in North Carolina with my fellow journeymen and women was one of the most enriching experiences in my life. With a finely tuned mix of investment education and personal development techniques and models, Van challenged all our most tightly held belief systems and preconceptions about investing, relationships and reality itself. Nothing since has come close to those workshops.

Van’s contribution to the world of investing and trading deserves much deeper analysis. But in my estimation, there has been no better exponent of the importance of position sizing in determining trading success. Van’s trading games in his workshops revolutionized the way I thought about what is often diminished in other investing body of works. Of course, trading psychology perhaps best encapsulated by his ‘Twelve tasks of trading’ should be instilled into every young trader.

But for Van the man, I will never forget his hospitality and generosity. He would often hold gatherings at his house with his radiant wife, Carla, where we would mingle and socialize with other attendees and staff after a grueling workshop. There, we would discuss, laugh and decompress from a day of exercises which more often than not had brought about a major breakthrough moment for many of us. I met some truly amazing, inspirational people during those weeks, and this was another one Van’s amazing gifts; he brought people together, from all around the world, with vastly different backgrounds and perspectives. Transformation is an often overused and over sensationalized word. But from my own personal experience and what I witnessed happen to others during those weeks, could only be described as Transformational.

Thank you, Van. As you would have said, you have moved into the light.

• Books by Van Tharp
• Market Wizards: Interviews with Top Traders by Jack D. Schwager