Why are gold and equities moving up together?

Since late October 2011 gold and the equity markets have become closely correlated. This raises two rather more important question than it at first appears. Firstly, why? And secondly, what does this mean for gold's safe-haven status?

In a recent survey of hedge funds by Barclays Capital this week, it was stated that "Portfolio diversification" is the number one reason for buying into commodities, supported by over half of all respondents. If, however, gold and equities are becoming increasingly correlated, then this could potentially kill the most important motivation for would-be buyers.

On the year to date spot gold has gained 12.5%, the S&P 500 is up 7.5%, the DJIA is up 5% and oil is up 5%. Meanwhile the USD dollar index is off nearly 3%.

Our reading of this is that there are two reasons for the correlation — one coincidental and the other a natural consequence of economic remedies. The 'coincidental' argument runs that gold is still benefiting from a technical correction following the 25% fall in September of last year — the current price strength should be seen within the context of the 50% price retracement. In addition, there has been some phenomenal buying from China (quite at odds with a near-vacuum condition in Europe at this time!), which is quite probably linked to buying for the Chinese Central Bank. Meanwhile oil is fixated upon Iran, while the equity markets have been given a shot in the arm from some hitherto positive economic data out of the USA.

The economic remedies argument runs that the 'easy money' and low interest rate economic remedies favor both gold and equities, but for quite different reasons. It helps gold because it creates the possibility of inflation down the line while low interest rates continue to make it unappealing for gold producers to want to sell forward and thereby effectively killing the bull-run. For equities it eases concerns about the availability of credit for companies plus it makes equities look more appealing than other interest-bearing asset classes.

So what does this tell us about gold's role as a safe-haven asset? In short, gold seems to adopt that guise only during an economic but (and this is the important bit) only when it moves above a threshold (for example the VIX index above 30 (it is currently at 18)). Below that threshold and gold returns to more prosaic drivers.

Gold bulls can therefore be assured that the uncomfortable correlation between gold and equities means relatively unimportant for now — correlation and causality are, after all, not the same. The second most popular motive for hedge funds for buying gold in the Barclays Survey was "absolute returns" with about 30% support. In that desire the funds have certainly been well rewarded.

Gold is currently trading at $1,784 having received a short sharp lift following the €530 ECB injection. The market looks likely to test the highs from Nov. 14 2011 at $1,796 plus possibly the psychologically important $1,800 level this week, while support is pegged at $1,767.

Norman is owner and chief executive officer of the London-based gold broker Sharps Pixley Ltd.

www.SharpsPixley.com

About the Author
Ross Norman

Ross Norman is owner and chief executive officer of the London-based gold broker Sharps Pixley Ltd.

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