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Why Gold and Silver Correlations Must Be Monitored Constantly

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Correlations should be constantly monitored in order to avoid formulating conclusions and forecasts automatically.

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Now, let's have a look at the USD Index short-term chart.



Here, we have similar implications to what was seen from the long-term perspective. The index dropped significantly on Thursday after an unsuccessful attempt to break out above the declining resistance line based on tops seen last year in July and November. The invalidation is a bearish factor and likely a major contributor to Thursday's decline. The index closed even lower on Friday after having tried to move much higher that day which is a bearish indication. It seems that additional moves to the downside are ahead along with additional rally in the Euro Index.

An encouraging development last week was that the precious metals rallied when the USD Index declined, seemingly a step towards return to normalcy, that is, negative correlations between the dollar and the metals. We would like to see more of this, however, before stating that this bullish development is once again in place.

Finally, let us have a look at the intermarket correlations to see how what we saw last week translates into the numbers, and whether we can expect any improvements in the correlation structure soon.



The Correlation Matrix is a tool which we have developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector (namely, gold and silver correlations). On Thursday we saw something that contributed to a possible move back to the normal correlations. It is too early to say, however, that the negative correlation between gold, silver and the mining stocks and the USD Index is definitely back. What's normal? Negative correlation between metals and the dollar and positive one between metals and stocks – just like you can see in the medium term columns.

Why should you care? Because without this correlation in place, lower values of USD Index may not translate into higher values of precious metals – this is what we've been seeing for a few weeks now.

We prefer to see a few more days of declines in the dollar and higher prices for precious metals before saying that the worst is over with respect to the upside down correlations. While it is more likely than not that lower values for the dollar will coincide with higher precious metals prices, this is not yet something we would describe as "highly likely." Correlations should be constantly monitored in order to avoid formulating conclusions and forecasts automatically – someone who's heard that "when USD rallies, gold falls" could decide to sell the yellow metal because of the strong dollar and lose lots of money in the profits that they would not make – that could be the case when gold rallies along with the USD Index, when it's being pushed higher by the demand from Europe and Asia. Such scenarios will likely take place some time during this and/or the following years, so it is important to keep the correlations in mind and check them before taking big steps regarding your gold and silver investments.

Summing up: The outlook for the euro is bullish for the short term but bearish for the USD Index for both the short and medium term. The implications from the currency markets this week are bullish for the precious metals sector overall, but may have no direct, instantaneous effect until correlations return to their normal values.

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.

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