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Minyan Mailbag: Negative Correlation Between Gold and Stocks?


Gold is not a short sale of the stock market. It's a store of value and a "hard" currency.

Prof. Lewis,

I've noticed an observable change in the minute-to-minute behavior of the gold price and was hoping you could comment. For quite a while, the gold price seemed to rise and fall perfectly with the US stock futures. It rose with the price of oil and with all other metals and acted as a commodity. But for the last two weeks, it seems to have diverged. When the stock futures go up on my 5-minute chart, streetTRACKS Gold Shares (GLD) declines and vice-versa (not 100%, but getting stronger every day).

I have for a while felt that gold's rise in tandem with other commodities was merely coincidental and once the financial crisis really got off the ground worldwide it would diverge completely. Do you see the recent movement as potential confirmation of that view, or simply as a short term anomaly? Additionally, do you believe the gold stocks can continue to trade with beta while the metal they deal in doesn't? Or do you eventually see Newmont (NEM) and Barrick (ABX) as market leaders on down days and dogs on up days?

Thanks for your input,
Minyan Matt


I haven't noticed a tight negative correlation between gold and the stock market like that myself. I guess we saw that to some extent last week when gold fell with crude as the dollar rallied and stocks bounced. But other than that short-term phenomenon, I don't recall really seeing the two diverge on a minute by minute basis on any sort of consistent basis, even though gold is obviously diverging from stocks to the upside on a longer-term basis, which we can see in the recent new lows in the Dow/gold ratio and SPX/gold ratio (see the charts below).

Click to enlarge

Click to enlarge

Will we see a minute by minute negative correlation between gold and stocks at some point in the future? Maybe, but I don't think that's necessarily a required evolution. Gold is not a short sale of the stock market. It's a store of value and a "hard" currency.

It just so happens that the current financial crisis is prompting the Fed (and now the BOC as well) to "run the printing press" and ease when they shouldn't, given where inflation is. Other G10 central banks with strong currencies will no doubt be easing at some point soon as well in order to weaken their currencies that are now crimping growth in their domestic export-oriented economies. It will eventually turn into a race to debase of sorts, I suspect, but at the end of the day, it's just another symptom of the general breakdown of the fiat dollar monetary system in my view. The bid in gold reflects the market's increasing lack of confidence in the continuation of that system in its current form due to the gargantuan size of the financial and economic imbalances that have developed over the past 25 years.

As for the gold shares, they'll always be tied to the stock market to some extent because they're equities at the end of the day. For example, as margin calls go out on heavy days of selling in the equity market, gold stocks can be liquidated too. But as we can see from the recent new high in the HUI/SPX ratio, gold stocks are diverging to the upside from the equity market on a longer-term basis and will likely continue to do so.

Click to enlarge

I'm not so sure we can say they will trade with "beta" consistently, though (and I assume you are referring to tech when you say "beta"). As you can see from the chart above, the gold shares obviously did quite well on a long-term basis from 2001-2002 when the NASDAQ (i.e. beta) was crashing, even though the same day-to-day stock market liquidity issues were affecting the gold shares back then as well. I guess what I am saying is that we shouldn't assume that just because some of the NASDAQ trash rallied strongly off the low in August along with the gold shares that this action is going to necessarily continue.

For example, should some form of stagflation increasingly become the problem for the stock market (which I believe it will), higher long-term interest rates (even if the Fed is easing in the short end) will pressure high beta NASDAQ stocks because of their high valuations, which tend to get compressed during periods of rising interest rates. Gold shares, on the other hand, should benefit from the higher gold price that comes along with that stagflation and outperform, just as they did in the 1970s.

Hope that helps,
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