Sunday, May 20, 2007

XAU:GOLD in Sync with the US Dollar?

The XAU:GOLD ratio is one of the classic buy/sell timing indicators for precious metals. The Gold Ratio is a blunt instrument, but significant ratio lows -- usually below 0.2 -- suggest a new PM buying cycle is near.

The Gold Ratio also has a long history of maintaining an inverse relationship with the US Dollar. A representative sampling of this is the 6-year period from 1995-2001.

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However, in late 2004, something very unusual happened: the Gold Ratio and the US Dollar began moving in parallel. Anything "gold" moving in parallel with a fiat currency is every goldbug's worst nightmare, and unfortunately it's a condition that persists to this day.

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Over the past three years, gold's de-correlation with other asset classes has seriously waned. It's even affected gold's most prized role as an inflation hedge. On numerous occasions (most recently May 11), the stock market tumbled on inflation fears -- but gold fell even harder. On May 11, the XAU was actually the worst performing sector.

Perhaps the most infamous de-correlation snafu in recent memory is gold's massive tumble during the May 2006 stock market correction. While the SPX pulled back 8%, gold fell 26%. The irony is that equities corrected in May 2006 in part because of the effects of hefty inflation on Fed policy. The SPX is now 15% above the May 2006 high, while gold is still 9% below, even though inflation remains stubbornly high and the US Dollar has fallen over 7%!

Some in the financial community contend that this unusual behavior is evidence that the price of gold is being manipulated. As the theory goes, the world's central banks are conspiring to keep the price of gold low to create the appearance of low inflation and provide fiat currency support. Another reason suggested for the XAU's odd behavior is that the miners are so heavily hedged that they can't benefit from gold demand.

Regardless, the only thing more interesting than watching the Gold Ratio parallel the US Dollar is to watch for the market force that will eventually wrench the two apart once more.



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