Gold And U.S. Government Debt: Highly Correlated

Includes: GLD, IAU
by: Eric Boughton, CFA

I heard a TV commentator discussing how, as US debt goes from $14 to $15 to $16 trillion, the price of gold goes from $1400 to $1500 to $1600 an ounce. Being naturally skeptical, I decided to pull some historical data on that relationship. Much to my surprise, I found that, back to 1975 (all data easily available), the price of gold on a quarterly basis is indeed 86% correlated (!) to total government debt. (The relevant indexes are GC1 Comdty, and DOUTFED Index, for those with Bloomberg.) In fact, over the past 15 years of data, the correlation is a shocking 98%!

Here is the scatterplot with the relationship: (The most recent datapoint, 9/30/12, is the one farthest to the right on the chart.)

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To see this a little better, I multiplied the gold price by 7 so the scale would be about the same, and charted both together over time. See below:

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Using this single relationship, it would seem like a no-brainer investment thesis to buy gold (NYSEARCA:GLD) at today's price as a proxy for the not-otherwise-investable thesis that US total government debt will increase in the future. However, one must consider the possibility that the gold price has already anticipated the future increase in US government debt. To test this, I looked at the historical ratio between US government debt ($blns) and the gold price ($/oz), which currently stands just above 6. The chart of this relationship is below:

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The current multiple of 6.37 is at a record distance (1.5 standard deviations) below the trendline ratio of 11.48. If the relationship returns to trend, then the gold price will "underperform" the change in US government debt from here forward. For example, if total debt goes to $17 trillion (from today's $11.3 trillion) over the next 5 years, and the ratio goes to 12.57 (continuing on the same trendline), then the gold price would go back down to $1352 by the end of that 5-year period. Something like that is my best guess, personally.

But the correlation is certainly startling!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.