If The Stock Market Tumbles, The Gold Price Should Rise

Includes: GLD, SPY
by: Tim Iacono

It certainly will not be called "The Great Rotation" because many investors in the U.S. still have to hold their nose when they buy gold, but the yellow metal is likely to benefit greatly from any stock market sell-off in the period ahead.

Why? Because, like in 2011 when the gold price reached its record high as U.S. stocks went through a sharp sell-off, the two are inversely correlated again. In fact, so far in 2013, there is an almost perfect inverse correlation between stocks and gold, a very unusual development.

With gold flows out of the SPDR Gold Shares ETF (NYSEARCA:GLD) slowing dramatically in recent days as equity markets have struggled, the mainstream financial media has focused on the relationship between stock prices and gold prices with this story at Bloomberg today being typical of the lot.

Gold rebounded to trade above $1,400 an ounce as equities retreated and the dollar's rally halted, boosting demand for the metal as a store of value.
"The decline in the stock markets appears to be lifting gold," said Huang Fulong, an analyst at CITICS Futures Co., a unit of China's largest listed brokerage. "The dollar's performance has kept gold in a tight range. We continue to watch ETF flows with interest."

It should be interesting to see how this plays out since financial markets have suddenly become volatile again, thanks in large part to developments in Japan. Bond yields are rising sharply in both Japan and the U.S. and this has made stock investors suddenly jittery.

After making a series of new all-time highs, U.S. stocks are now struggling to hold those levels. Meanwhile, after brutal sell-offs in April and May, the gold market continues to consolidate at around the $1,400 an ounce level, more than 25 percent below its all-time high from 2011.

But, that may all be about to change. As shown below, U.S. stocks and gold have had a fascinating relationship over the last decade, moving together for long stretches of time and then parting ways for a while, but never moving opposite each other as much as in recent months.

(Click to enlarge)

Slightly different results are obtained based on the timeframe selected and it's important to note that the correlations above are based on full year data for GLD weekly closes and the SPDR S&P500 ETF (NYSEARCA:SPY), except for 2013 where data through June 4th is used.

A brief history of the correlation is as follows.

After the GLD ETF was launched in late-2004, there was a fairly strong correlation between gold and U.S. stocks up until 2011 when the debt ceiling crisis in the nation's capital caused both the U.S. dollar and U.S. stocks to sink as the gold price soared.

There were periods in 2007 and 2008, before and during the financial crisis, when gold and broad equity markets diverged, but these were fairly short-lived affairs as compared to what has been seen in recent years.

The two mostly moved together in 2012 before a late-year swoon for gold led to record outflows from GLD and U.S. investors piled into stocks, pushing prices sharply higher.

So far this year, there is a near perfect inverse correlation between gold and stocks as evidenced by the -0.90 reading to the far right.

It's worth remembering that past performance is no guarantee of future results, but if recent equity market weakness develops into a long overdue correction (or worse), the gold price is likely to rise.

How much is anyone's guess since, after gold's April-May swoon, there is a good deal of technical resistance in the charts for traders who control short-term prices.

Much depends on what the Federal Reserve says and does in the months ahead as the threat of "tapering" their money printing effort seems to be injecting all sorts of new uncertainty into financial markets and, with inflation still very low in the West, it is this new volatility that has recently raised gold's appeal.

Whatever happens, it should be interesting to watch.

Disclosure: I am long GLD. 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. I also own gold coins