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Gold’s Relationship with Outside Markets

Gold’s Relationship with Outside Markets
June 08
16:48 2011

A relatively small proportion of the gold market is made up of banks or people who actually use gold in any way (either for commercial use or as a currency). Rather, it has become the haven for financial investors looking for a “safe” asset to diversify their portfolio in uncertain economic times. A lot of money has been pumped into the gold market for this reason, from retail investors as well as large funds. Because of this, whenever the performance of some unrelated market affects these investors’ and funds’ overall liquidity, it will also affect the gold market. Gold has established, fundamental relationships with certain other markets, but it’s also evolving the relationships it has with outside markets.

Gold is the “granddaddy” of the metals markets, which is to say it has the highest trading volumes and the most money being traded. However, as its price changes, the prices of other precious metals follow along quite closely. As you’d expect, silver, platinum, and palladium market returns are highly correlated with the gold market’s returns. Non-precious metals like high-grade copper, aluminum, and hot-rolled coil steel are also correlated to the gold market’s movements, but not so closely because they are subject to more changes in their industrial supply and demand situation than precious metals.

Each individual country and currency has its own unique relationship with gold, especially because people in some developing countries use gold in more ways and different ways than we do in the United States, but the U.S. dollar index is a good proxy to use when discussing gold’s relationship to currencies because the index itself is made up of a basket of foreign currencies, including the Euro, the Japanese yen, the Great British pound, the Canadian dollar, the Swiss franc, and the Swedish krona. This U.S. dollar index is strongly negatively correlated to the gold market. Over the past five years, weekly returns of gold and the U.S. dollar index have posted a -0.45 correlation.

Stocks and commodities
Most likely because gold has evolved into a market for traders to park their long-term investments, gold prices have grown a very strong correlation to the stock market since 2009. Prior to that time, weekly returns of gold and the S&P 500 were positively correlated, but not with the same strength they display now that both markets seem to attract the same investment dollars. This argument is also true for commodities in general, which should come as no surprise when one considers that precious metals make up 17% of the CRB Commodity Index, for instance. The correlation between overall commodity indices and stock market indices, or between overall commodity indices and between gold, is looser than it is between gold and the stock market, but it’s still positive.

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