Here’s Why Lumber and Gold Are Reasons for Worry on U.S. Stocks

Lumber-gold ratio

Commodity markets are signaling that lower prices and bigger swings lie ahead for U.S. stocks, according to Charlie Bilello, research director at Pension Partners LLC.

The attached chart illustrates how Bilello reached his conclusion: by tracking the price relationship between lumber and gold. The chart displays a ratio of futures prices at the Chicago Mercantile Exchange and New York’s Comex, respectively. The Standard & Poor’s 500 Index is also provided for reference.

“When lumber is leading gold, volatility in equities tends to fall going forward,” Bilello wrote in a blog posting three days ago on his New York-based investment firm’s website. “When gold is leading lumber, the opposite is true.”

This year, the ratio has fallen as much as 27 percent as lumber futures have tumbled, reflecting a drop in U.S. housing starts. Gold, which many investors see as a haven in periods of economic and political turmoil, was little changed for the year as of yesterday.

While the S&P 500 gained 2.4 percent for the year through yesterday, the lumber-gold indicator shows investors need to be more defensive, Bilello wrote. “At the very least, if history is any guide, we should be prepared for higher volatility ahead,” he added.

The ratio is the subject of a paper by Bilello and Michael A. Gayed, chief investment strategist at Pension Partners, that won an award from the National Association of Active Investment Managers. The paper covers the use of the indicator to switch between stocks and Treasury securities, and will be published next month. An abstract is now available.

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