– John Jagerson and Wade Hansen: Gold can be thought of as a currency of its own, which means that when we talk about the value of gold, we are also talking about the value of the dollar in gold terms. Because gold is largely priced in dollars (like oil), gold prices tend to fall when the dollar rises in value against other currencies, and vice versa.
This inverse relationship isn’t 100%, so those few times that gold rises with the dollar can be very informative.
A positive relationship between gold and the dollar has reemerged over the last few trading sessions. This correlation is too new to draw firm conclusions from, but it needs to be watched carefully. That is doubly true right now, while bonds are rising and bond yields are falling. If bonds continue to rise with gold and the dollar, it would indicate that investors are becoming more risk-averse and seeking so-called “safety assets.”
As you can see in the next chart, the dollar, gold and bond yields (inverted to show the correlation) are trending contrary to their normal relationship. If this correlation occurs when the stock market is dropping, like it did in January 2016, then it’s not that remarkable because that is what we would expect to happen. However, when this correlation picks up while the market is rising (like it is now), then we want to take notice.
US Dollar Index (candles), SPDR Gold ETF (red bars), Inverted 10-Year Treasury Yield (blue bars)
We saw this same short-term phenomenon pop up just before the June 2016 decline and the top of the market a month later in July. This happened in late September last year as well, although we can probably attribute that to unease about the then-upcoming election.
This sort of risk indicator is not a harbinger of a bear market. However, it does commonly occur just before short-term corrections. We have already been seeing some subtle signals for a few weeks that the market is looking a little “toppy,” so this adds a bit more weight to the current concern that the major indices could drop back to support by the end of the first quarter.
Stock traders aren’t the only investors feeling a little uneasy about the trend of safety assets. High-yield-bond analysts have become more and more vocal lately about risky high-yield bonds looking overextended as well. While the election of Donald Trump was a huge boost for asset prices in the U.S., the emergence of populist candidates in France (and the rest of Europe) is not the same kind of good news and may be the root cause of this unusual correlation.
The good news is that more and more signs are pointing to a breakout in volatility. The S&P 500 hasn’t traded in this tight of a range for this long since 1995, which is a very challenging environment for option traders. We like volatility and the quick profits it can generate, and we plan to maintain a balance of bearish and bullish trades while we wait for a stronger move.
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