GOLD and SPY

Itinerant

For most of this year so far it seems that sentiment has been increasingly risk and yield seeking which has favoured the stock market over gold. Low interest rates in combination with generously supplied liquidity has led to a stock market rally to new previously unexperienced highs, and a gold price correction that has turned bugs into bears.

It seems that it has almost become common knowledge that the gold price must go down as long as the stock market is going up. Forgotten are the times when gold and stocks have marched in lock-step, be that up or down. And now our data indicates that the recent strong inverse correlation between the stock market and the gold price is in the process of breaking down again. It may just be that gold is swinging back in line with the general stock market again.

In the following we shall use the SPDR Gold Trust ETF (GLD) as a proxy for the price of gold. The daily price data can be readily downloaded from Yahoo.com all the way back to its inception in 2004. And for better or worse we shall use the SPDR S&P 500 Trust ETF (SPY) as a proxy for the performance of the stock market. Again, the daily price data can be downloaded from Yahoo.com.

We used this data and correlated the daily closing prices of the two funds. The chart below shows the price performance of GLD and SPY respectively, plus the 100 day moving correlation between the two.

To be clear: every point on the blue line gives a reading for the correlation between the S&P 500 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 SPY 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.

(click to enlarge)

In this chart we can observe 5 periods of time since 2005 with a strong correlation between GLD and SPY, and only 3 periods with strong inverse correlation. The most recent period of inverse correlation is clearly visible at the right hand side of the chart. However, we also observe that this inverse correlation has broken down and correlation between the GLD and SPY for the past 100 days has been almost exactly zero.

Consider the next chart below showing the same 100 day moving correlation again in blue, plus the red line for a moving correlation period of 200 days. As could be expected, the 200 day line is a little more sluggish in its moves. We also observe that if the 100 day line crosses zero correlation from a previous peak the 200 day line usually follows. And this is what seems to be happening at the moment.

(click to enlarge)

If performance of the past nine year can serve as a template then we can expect GLD and SPY moving in parallel again shortly. In other words: if our reading of this correlation analysis proves correct, then we need to start looking to the SPY for clues on GLD.

During the past couple of weeks we have pointed to our observation of fewer and fewer stocks participating in the rally as a possible sign of an impending stock market reversal. This concern has all but evaporated during the past week. Sentiment seems high and we are expecting new highs in the S&P 500 in coming weeks.

If both our calls are correct, then we would expect the stock market dragging gold higher in coming months, which would be a nice and long awaited change for gold bugs.

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