Is the Rising Stock Market Bullish or Bearish News for Gold?

By Przemyslaw Radomski, CFA  OCT 18, 2013 10:30 AM

The bullish invalidation of the breakdown in stocks and this week's breakout are important because of the negative correlation with gold and silver.

 


On Thursday, the S&P 500 (INDEXSP:.INX) closed at a new high, and its intraday record of 1733.45 broke the all-time high set Sept. 19. Over 80% of stocks traded on the New York Stock Exchange rose. According to FactSet, companies in the S&P 500 Index are on track for third-quarter earnings growth of 1.1% from last year. Excluding JPMorgan Chase's (NYSE:JPM) loss, they would be on pace for 3.6% growth. Please note that at the beginning of earnings season, analysts expected earnings growth of 3%.
 
Taking into account the fact that there are no technical resistance levels at the moment, it seems that stocks could continue their rally in the coming weeks or even months. Additionally, with Janet Yellen scheduled to take over as Fed chief, the stock market should increase as long as inflation remains low and unemployment remains elevated.
 
And speaking of the Fed…

According to Reuters, many investors think that damage done to the US economy by the 16-day government shutdown and uncertainty over the next round of budget and debt negotiations may keep the Fed from withdrawing monetary stimulus until at least a few months into next year.
 
The Fed's taper decision will ultimately be tied to the economic data. In the coming week all eyes will be on the crucial nonfarm payrolls report. The report was originally scheduled for release on Oct. 4, but because of the government shutdown, it will be released next Tuesday.
 
It seems that the US debt deal and a rather unlikely reduction of Fed asset purchases are positive for both gold and the general stock market. However, let’s not forget that these two markets moved in opposite directions in the past few weeks. The question becomes, how will the current situation in the general stock market impact the gold market? Before we try to answer this, let's take a closer look at the charts to find out what the current situation in the general stock market is (charts courtesy of http://stockcharts.com).
 
S&P 500 Chart SPX
Click to enlarge
 
Looking at the above chart, we see that the invalidation of the breakdown below the rising medium-term support line has indeed triggered the expected rally in the past few days. The S&P 500 rose and actually moved above its September 18 top. There was no analogous breakout in case of the Dow Jones Industrial Average (INDEXDJX:.DJI), though.
 
The outlook is bullish and -- as you will see in the section about gold ahd silver correlations -- the implications for gold are bearish.
 
Let’s turn now to the financial sector, which in the past used to lead the rest of the general stock market.
 
Broker Dealer Index XBD Chart
 
As written in previous article on the general stock market on October 15: "...since the support created by the 2011 high is relatively close, we will likely not see another major decline."
 
On the above chart, we clearly see that, in spite of the last week’s downward move, the financial stocks didn’t invalidate the breakout above the level of 130. These positive circumstances triggered an upward move this week, which took the financials to slightly below the September high.
 
Consequently, the medium-term outlook remains bullish. Please note that the financial stocks proved once again to be a reliable indicator in estimating whether the trend is about to change or not.
 
Now that we know the current situation in the general stock market, let’s see how it may translate into the precious metals market. Let’s take a look at my firm's Correlation Matrix -- a tool designed to measure, present, and provide interpretations of correlations between various parts of the precious metals sector and key markets that impact it, specifically, the USD Index and the general stock market.
 

 
In the previous week, the correlations have turned upside down in the short-term (30-days) column. The most interesting thing about these coefficients is what actually caused them to reverse. In the case of the USD Index, it was the fact that metals managed to decline even when the dollar declined (bearish implications). In the case of the general stock market, it was the fact that metals managed to decline along with a decline in stocks.
 
The bullish invalidation of the breakdown in stocks and this week’s breakout are so important because of the significant and negative correlation with gold and silver. Naturally, the bullish action in the stock market is bearish for the precious metals sector.
 
Recently (mainly on Thursday), we've seen some strength in precious metals and mining stocks, but this was not enough to change the most important correlations. In the case of gold, silver, and the general stock market, the correlations remain strongly negative. Although the correlation between miners and the S&P 500 is weaker, mining stocks are not likely to move anywhere without metals moving in the same direction, so the negative impact of the stock market’s rally should also be seen in case of mining stocks – if not directly, then most likely indirectly, and if not immediately, then eventually. On a side note, correlation does not imply causation by itself, we estimate the direction of the relationship (for instance that the general stock market impacts mining stocks, not the other way around) based on fundamental information and our experience.
 
Summing up, the long-term, medium-term, and short-term outlooks for the stock market remain bullish, which is a bearish factor for the precious metals market.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.