Gold Market: Correlation Breakdowns Doesn’t Bode Well For Prices - ANG Traders
(Kitco News) - Correlations breakdowns between gold and critical financial markets could be a troubling signal for the yellow metal, which has seen a strong start to the new year, according to one trading firm.
In a research note published on Seeking Alpha Tuesday, analysts at ANG Traders said that they had noticed a breakdown in gold’s correlation to inflation expectations, and its negative relationship to treasury yields. At the same time, the yellow metal has managed to maintain its negative correlation against the U.S. dollar index. The analysts raised concerns about a growing positive correlation between gold and the currency pair USD/JYP; however, that appears to be resolving as the Yen is gaining against the U.S. dollar as the yellow metal holds near 3.5-month highs.
“Gold is displaying odd behavior in three of the four correlated markets, and because the bias in rates is to the upside, inflation expectations will remain contained, making the balance of probabilities point to future weakness in gold,” they said in the report.
Probably the most unsustainable breakdown, according to ANG, is a stronger gold price in the face of higher bond yields. The assets have a high negative correlation as higher bond yields increase gold’s opportunity costs.
ANG noted that since the beginning of December the correlation has turned positive. The positive correlation was on display Wednesday as 10-year bond yields jump nearly 10 basis points during the trading session to 2.57%, its highest level since mid-March. At the same time, gold continues most of its gains since the start of the year, last trading at $1,319.80 an ounce.
“A reversion to the mean is almost guaranteed,” the analysts said. “This means that either gold drops in price as rates continue to rise, or rates drop and gold continues to rise. We think this odd behavior is more likely to resolve itself by gold dropping in price since the bias in rates is definitely to the upside.”
Looking at inflation pressures, which is positively correlated to gold, ANG said that this relationship has now turned negative for the first time since mid-2016.
“In 2016, the negative correlation signaled the start of a 15% slide in the gold price,” the analysts said. “Also, rising rates are likely to keep inflation expectations contained and gold under increased pressure, like in the second half of 2016.”
Finally, the only relationship that remains in sync with gold is its negative correlation with the U.S. dollar. The analysts noted that this does not bode well as the U.S. Dollar Index appears to be regaining momentum after a dismal end to 2017.
“The dollar may be about to rally, and if the negative correlation holds, then gold will give back most or all of its December price appreciation,” they said.