I'm always on the lookout for correlations and shifts in correlations. The way related instruments move (or diverge) tells us huge amounts about what is driving markets.
Some markets are correlated in a very close way (for example USDCAD and oil (USO), or the Dollar (UUP) and precious metals (GLD) (SLV)), and there are fundamental reasons for this. Actually, the closest correlation I've seen for gold is with 30yr T-bonds/Dollar, as pointed out by Steven Saville in his article.
However, the directness of the correlation is also its drawback. When one ticks up, the other ticks down and there is very little to deduce until there is a meaningful divergence.
There are however, correlations that are delayed, and less obvious. This gives us more opportunities as traders. Here's one that is quite bizarre, but has logic, as explained in my July 13th article:
These two don't move tick for tick, and actually, the Nikkei opens over 12 hours in advance of the U.S. each day so there is a usable edge. For example, at the June lows, if you liked how the Nikkei gapped up on the 27th and held the gains, you may have had more confidence buying the GS gap down later that day.
This is slightly diverging from what I wanted to say, but serves to introduce the concept on the next chart:
I thought gold and equities were meant to move inversely?
Actually they do - at times - the S&P 500 (SPY) chart above is shifted over by a month. The gold moves in late 2015-2016 have led those of the S&P 500.
This brings up some interesting questions. Firstly, you have to ask, 'why'? Co-incidence surely doesn't create patterns this close?
What fundamental catalyst(s) would cause gold to rally and make these specific combination of rallies and pullbacks, then cause the S&P 500 to follow them in nearly exact proportion a month later?
I'm not going to even attempt to answer that one. I have a very good eye for patterns, but I don't know the underlying cause for every market move. If you want to give it a go, I'm all ears in the comments section...
The second, and most important, question is will the S&P 500 continue to follow gold's lead? If so, the current move down in equities will continue. A proportional decline would take the S&P 500 down into the 2060s. By that time, gold should have made its next move and we will have a continuing guide.
At the moment, I don't want to say if equities will follow gold down. I have lightened equity longs, but I think the S&P 500 will hold the 2090s. However, if it continues through there I will take a good look at what gold is doing and has done and I will expect a similar path.
A Different View
At the moment, the above is just an observation. I wouldn't call it an actionable idea as I'm not taking any action. It may turn into one, but at a later date.
This is what has caused the lead/lag and the correlation:
This chart shows gold and the S&P 500 with the dates lining up as they should (without the month shift). It reveals another pattern.
Since the December 2015 rate hike, there are distinct two-month cycles. First gold and equities move in inverse, then equities rally as gold consolidates. There hasn't been a change to this sequential relationship all year.
The current cycle in the series suggests gold and the S&P 500 should move inversely over the next month and a half. So far, the moves have been slightly erratic; you can't look at individual days or periods where the moves are a mirror image.
Over the longer term, it is worth monitoring and if the equity decline suggested by the first chart materializes, gold should find a bid. Of course, the reverse is also true. I'm pretty nervous about my short gold, long equity exposure at the moment, and I can only hope the S&P 500 holds the 2090s as expected. We shall see.
One last chart to give me sleepless nights: gold divided by S&P 500:
This again suggests, both fractally and because price is moving into support, that gold will soon start to outperform equities.
The more I write, the more I want to reverse my positions. I'll leave it there for now... time to refine my exit strategies.
Correlations are helpful, but not normally easy to trade as any discrepancies narrow very quickly. Sometimes it pays to look at things from a different angle. Correlations don't always move 1:1, or exactly inverse as you may expect. Gold and the S&P 500 is a good example of this.
I can't really conclude with an actionable idea. But hopefully I leave you with an interesting concept and a few charts to keep a close eye on. How you choose to approach them is down to you as an individual. I haven't even figured out my own plan, yet... wish me luck.
Disclosure: I am/we are short 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.
Additional disclosure: I am short gold futures. I am long various stocks, and recently closed a long in the S&P500 futures.