Gold And The Dollar: One Up, One Down

| About: PowerShares DB (UUP)

In our recent article on correlation between the gold price and the S&P 500 (NYSEARCA:SPY) we received several comments from readers pointing to the relationship between the Dollar Index and the gold price.

Common wisdom maintains that the gold price goes down when the dollar index goes up and vice versa. Not so common wisdom has described the relationship by referring to a drinking game referred to in the title of this article.

The chart below shows the performance of the dollar index and the gold price since 1994 and intuitively one can be tempted to concur with common wisdom.

^DXY Chart

^DXY data by YCharts

Not wishing to rely solely on a "temptation to concur" we proceeded to perform some analysis. For this analysis we used the SPDR Gold Trust Fund (NYSEARCA:GLD) as a proxy for the gold price and the PowerShares DB USD Bull ETF (NYSEARCA:UUP) as a proxy for the dollar index. Performance data for these two ETFs can be readily downloaded from all the way back to the inception of UUP early in 2007.

We used this data and correlated the daily closing prices of the two funds. The chart below shows the price performance of GLD and UUP respectively, plus the 100 day moving correlation between the two. The movements of the UUP ETF is barely visible in comparison to the wild swings of the gold price for the observed time frame.

Every point on the blue line gives a reading for the correlation between the dollar index as represented by UUP and GLD for the 100 days preceding this point. Correlation is measured on the secondary right axis of the chart, while share prices for GLD and UUP are measured on the primary left axis. We shall consider values of greater than +0.8 as a strong correlation, and values less than -0.8 as a strong inverse correlation. The areas shaded in grey on our chart below indicate these areas.

Quite clearly, the correlation line spends most of its time in the lower half of the chart indicating an inverse relationship between UPS and GLD. The one exception to this rule is a period of time in 2010 where the two were rather strongly correlated.

This observation becomes even more pronounced when we increase the correlation time frame to 200 days. The chart below shows this 200 day UUP - GLD correlation line in red; plus the same line for correlation of GLD and S&P 500 as discussed in a previous article for comparison in blue. The red line remains in negative territory for most of the past four and a half years with only the one mentioned exception in 2010 while correlation between GLD and SPY has oscillated quite significantly.

In recent weeks this inverse correlation has weakened, but judging from the 100 day correlation line in the second chart it is currently heading back towards a stronger inverse correlation.

There has been ample commentary referring to a weakening dollar index as a result of ongoing QE, government shutdown and other reasons. If the observed predominantly inverse correlation between the dollar and GLD remains intact then this would clearly represent a bullish indicator for GLD.

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.