Has Gold Become Correlated to the Stock Market?

I’ve been an avid collector of gold and silver coins and have been following their prices for years. Gold is supposed to have a negative correlation with the stock market. This year has proven otherwise. Of course, as we’ve seen repeatedly in the past, all asset classes correlate to the downside.

Gold which peaked at $1030/oz earlier this year, has been trading in the $700 range for a few months. There has been a flight to safety, which for most people means buying U.S. Treasuries. Indeed, the flight has been so large that it has pushed the yields down to absurdly low levels. The yield on the 3-month Treasury was almost zero at 0.4% and the 10 year is 3.52%. (The yield on the S&P 500 was 3.55% this week, higher than the 10 year Treasuries rate for the first time since 1958).

The way that demand affects interest rates is that as people clamor for T-bills, they push up the prices for these bonds. Since the bonds pay out a fixed interest rate, the effective yield (also called yield-to-maturity or YTM) drops. So it’s the demand for stability in the current globally volatile economic environment that is pushing up bond prices and pushing down yields to almost nothing.

On the flip side, prices for a product fall as the demand drops off. So we’d expect the decrease in demand for gold is the cause of its low price. However, there have been several news reports stating that demand for gold is 50% higher than it was last year. [Demand For Gold Hits A Record Even As Institutions Head For Exits (November 19th, 2008)]

The U.S. Government Mint had to suspend retail selling gold coins and silver eagles earlier this year, and the Perth Mint just announced suspending production of gold coins. So even though there is an increased demand for Gold, the prices haven’t been increasing proportionately. There have been several articles speculating on the reason for this.

According to The Disconnect Between Supply and Demand in Gold & Silver Markets (August 18th, 2008):

Obviously, enough people are willing to pay for gold and silver, at the previous $978 and $19.50 per troy ounce price, because the U.S. Mint could not source enough metal at those price, and had to suspend coin production.

This proves that people are more than willing to fork over, in whatever currency they are using, the previous prices for gold and silver, in such quantities, that a shortage was already existing, before the price collapse, especially in the silver market. It is true that people in poorer countries like India, might have back on their consumption.

But, while they were cutting back, demand and consumption of gold in North America, including Canada and the USA, was soaring. For example, before it suspended production of bullion coins, due to shortages, the U.S. Mint’s statistics show that it was printing 2.5 times as many gold coins, and almost 4 times as many silver bullion coins, this year, compared to last year. Gold and silver bullion, in bar form, was also flying off North American retail shelves.

Bottom line: Enough people were buying, when the price was high, to exhaust the supply. Basic economics says that, in a free market, this means the price must rise.

Seems like something's fishy in Denmark! The author further adds:

We have a disconnect between reality markets and fantasy markets. The COMEX and London Metals Exchange are fantasy markets controlled by the big bullion banks. They must be engaged in market manipulation, because nothing can explain a big price collapse, in the midst of widespread shortages and robust demand. A group of big financial institutions, deeply enmeshed in the global trading system, and heavily involved in the gold and silver market, must be deliberately inducing temporary panic, for their own purposes. These malevolent characters will eventually be able to buy back their short positions at low prices, and, possibly, also, even collect a significant long position.

I definitely think the prices are being manipulated, even though I’m not entirely sure why. One thing I do know is that you cannot manipulate prices indefinitely. Especially in the face of rising demand. Here’s an interesting snippet from the The Standard, Nov 14:

Hong Kong: The mainland is seriously considering a plan to diversify more of its massive foreign-exchange reserves into gold, a person familiar with the situation told The Standard.

China’s fears about the long-term viability of parking most of its reserves in US government bonds were triggered by Treasury Secretary Henry Paulson’s US$700 billion (HK$5.46 trillion) bailout plan, which may make the US budget deficit balloon to well over US$1 trillion this fiscal year.

The United States holds 8,133.5 tonnes of gold reserves valued at US$188.23 billion. China holds gold reserves of just 600 tonnes, worth only US$13.89 billion.

Beijing’s reserves could easily go up to 3,000 to 4,000 tonnes, Tanrich Futures senior vice president Colleen Chow Yin-shan said.

That article was published last week when gold was trading under $720/oz. Since then, it's jumped to almost $800/oz, with most of the move occurring Friday.

Click to enlarge

The bright green line is Friday’s movement. Gold moved from under $750 to nearly $800. Looks like gold has become strongly correlated to the stock market after all!

I think the price of gold will continue to rise over the long term. It’s just a matter of how long it takes.

Disclosure: None

Comments

[xsuddensam:]

It's no coincidence that the price of gold and silver are unreasonably low while the dollar has suspiciously run up.

2008 Nov 24 08:44 AM

[Adrian D:]

The financial crisis has businesses selling off their gold assets at fire sale prices just to stay solvent.

Lehman Brothers sold off more Gold ETF's in October than were sold in the entire year previous.

With more companies needing quick cash to meet debt payments, the down ward pressure on gold will continue. But there will be a turning point when all these assets are finally sold off

Adrian D.
world-gold-coin-prices...

2008 Nov 24 09:09 AM

[socrateazz:]

I think gold tends to move as the stock market moves based on the number of folk who keep rebalancing their portfolio based on a preset percentage formula. Since computors can calculate what needs to be changed at any set time period. Large portfolios can be rebalanced several times a day when there is a big move in some finacial area.

2008 Nov 24 09:37 AM

[User 30121:]

DECOUPLING has started my friends, and as I have said repeatedly in the past, when it happens, its "Katie, bar the door!" When gold (and silver) fully detach themselves from oil, dollar and whatever, you will see blood running. Citigroup (#2 bank on this planet Earth) is getting bailed out (another Sunday bailout), and more to come. The market is heading to 5500 or lower, and the price of oil, while currently languishing, will begin its accent to three digits once again. If you don't own gold and/or silver, PLEASE get some. You will wish you had in a very very short time! God bless us all!

2008 Nov 24 09:58 AM

[GMiki1:]

Gold isn't really correlated to the stock market. They can run together or run apart. The same is true for gold stocks. I have read a LOT about what happened at various times in panics and crashes. Gold may run with the markets for a while then separate. Gold can also go up with the dollar or run against the dollar. For safe haven buying, and we certainly need that now, go gold and silver.

2008 Nov 24 10:38 AM

[bearfund:]

It depends how you're measuring things. A credit crunch is a short squeeze in paper money, so if you're pricing other assets in paper terms it should not be surprising to see correlation during such a squeeze. Instead, price stocks in gold. If they're genuinely "correlated", you should see something that looks more or less linear with low volatility and a clearly-defined trading range.

Instead of that, you see this: stockcharts.com/h-sc/u...=$SPX:$GOLD&p=D&am...

With a 6-month range almost 50% wide, several 10%+ up and down days, a 34% drop in that time, and no clearly-defined trading range, I find it difficult to argue that holding stocks and holding gold offer similar returns. The proper way to price all assets is in gold. Over the last 6 months, gold has offered the same return it always does: zero. In that same time, stocks are down something like 1/3 and paper money (in the form of US dollars) is up about 10%. Don't those figures look a lot more like what you'd expect? A short squeeze in paper money has pushed its price higher. Stocks, a leveraged inverse play on paper money due to their financing needs, are lower by a larger amount. Seems perfectly reasonable, no?

Don't let the price of paper money deceive you into absurd conclusions about the markets. Price everything in gold and it will all make sense.

2008 Nov 24 10:47 AM

[zinfool:]

Gold has correlated to the markets for a while now. The hedge fund buying of gold and silver, and then the huge hedge fund redemption, margin calls, and derivative melt down, has caused gold and silver to move with the markets rather in their normal inverse move to market conditions. The commodities bubble also caused by the hedge funds, has multiplied the effect, adding more volatility, and has pulled precious metals along for the ride.

2008 Nov 24 12:07 PM

[econjunkie:]

I don't think that the stock market and gold are correlated...the data doesn't support it. Commodities as an asset class have done really well. Rogers pointed me towards myths about commodity futures or a paper with a title along those lines. It's a good paper. I have no idea where gold is going with respect to it's fundamental supply and demand, and I don't know what it's equilibrium price should be. It seems like a less transparent game than energy commodities.

2008 Nov 24 12:39 PM

[xsuddensam:]

Peter Schiff, who made the early call back in 2006 that there would be a housing meltdown and who correctly called $1,000 gold, predicted last week "the dollar is going to drop like a stone" and gold will hit $2,000 next year.

This guy has been so right on the money in his predictions that it's scary.
Take it for what it's worth. Check out his site:

www.europac.net/

2008 Nov 24 02:41 PM

[Bron Suchecki:]

You say the Perth Mint is "suspending production of gold coins" when the title of the article says "suspends orders" and then goes on to say "staff working seven days a week, 24-hour days, over three shifts to meet orders". Doesn't sound like production has stopped.

2008 Nov 25 10:58 PM