Friday, May 11, 2007

De-correlation in the Precious Metals

I received a couple of comments on Thursday about the precious metals. If you'll recall, they fell worse than the stock market on inflation-rich economic data, offering no refuge for gold bugs in their time of need. One comment touched on the fact that the correlation dynamic of precious metals with the stock market has changed over the past year. It's a good observation and something I've had my eye on as well.

While the long-term intrinsic value of PM's is an arguable point, nonetheless they remain a tradable asset class. This makes PM's susceptible to all the short-term delights a market has to offer, including big valuation swings, bubbles, de-correlation, etc.

The real wake-up call that the PM dynamic had changed was the May 2006 correction. Surprisingly, both stocks and gold tumbled, and gold fell especially hard -- 26% in 6 weeks -- while the Composite fell just 15%. However, the kicker was the July bottom. The chart below shows that the NASDAQ bounced back and has held up well against gold for the past 11 months.

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Meanwhile, a weekly chart shows that gold has been even money for a year, while the USD has tumbled 7% (perhaps the oddest thing of all). Now, gold appears to be developing a bearish snout. While many contend that the July 2006- present stock market rise has been an inflation-driven affair, gold's weakness suggests that something else may be going on.

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Since both the red and blues are climbing, gold remains in an uptrend. However, other asset classes are outperforming the PM's, so a light touch at this point is probably a wise idea.



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