Will the Situation in the Stock Market and in the Dollar Affect Gold?

By: Przemyslaw Radomski, CFA | Fri, Mar 30, 2012
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Based on the March 30th, 2012 Premium Update. Visit our archives for more gold & silver analysis.


 

This Wednesday Goldman Sachs reiterated its position that investors should buy gold. Goldman Sachs remains bullish on the precious metal, citing the familiar fundamentals-- low interest rates and subdued economic growth as catalysts for gold prices to rise this year.

Goldman economists expect another round of quantitative easing from the Federal Reserve will weigh on the U.S. dollar and push gold higher. From Goldman:

Gold prices remain too low relative to the current level of real rates. Under our gold framework, US real interest rates are the primary driver of US$-denominated gold prices. However, after being remarkably strong in the first half of 2011, this relationship broke down last fall, with gold prices falling sharply in the face of declining US real rates, as tracked by 10-year TIPS yields. While gold prices have returned to trading with a strong inverse correlation to US real rates since late December, at sub-$1,700/toz they remain below the level implied by the current 10-year TIPS yields.

The gold market's expectation that real rates would be rising along with economic growth may help explain this valuation gap. We believe that despite last fall's decline in 10-year TIPS yields, the gold market may have been expecting that real rates would soon be rising along with better economic growth, leading to a sharp decline in net speculative length in gold futures. Accordingly, a simple benchmarking of real rates to US consensus growth expectations suggested a level of +40 bp by year end. Our models suggest this higher level of real rates would be consistent with the current trading range of gold prices. As we look forward, our US economists expect subdued growth and further easing by the Fed in 2012, which should push the market's expectations of real rates back down near 0 bp and gold prices back to our 6-mo forecast of $1,840/toz.

The firm says that strengthening U.S. economic data would represent a growing risk for gold.

"We reiterate our view that at current price levels gold remains a compelling trade but not a long-term investment," Goldman says.

In general, we disagree, as we believe that gold is a very good long-term investment. To see how the USD Index and the general stock market fit into this picture, let's move to the technical part of today's essay. We start with the USD Index chart (charts courtesy by stockcharts.com).

$USD (US Dollar Index - Cash Settle (EOD)) ICE

This week the index moved a bit lower, down 1.64 or 2% since last Thursday. It is no longer close to its 2011 high and prices are now visibly below the 80 level and more or less at the long-term resistance line. No breakout has been seen so far.

$USD (US Dollar Index - Cash Settle (EOD)) ICE

In the short-term USD Index chart, it appears that we may see another small rally in the days ahead. A cyclical turning point is at hand, and with declines having been seen for a couple of weeks now, a local bottom could form followed by a small period of moves to the upside. If it does occur, it will likely be short lived since the main, medium-term trend is now down.

Although the very short term may see some strength here, this does not necessarily translate to weakness in the precious metals sector. A rally in both gold prices and the USD Index would result in gold appreciating from a non-USD perspective. In fact, this is something which appears to be in the cards as well.

Let us move on to the general stock market now.

$SPX (S&P 500 Large Cap Index) INDX

In the long-term S&P 500 Index chart, it seems that stocks may pause soon, as they're about to reach their 2008 highs. Thursday's closing index level was just 2-3% below this resistance line. If prices decline from here, they will likely not go lower than to the level of the 2011 highs. We would then expect the rally to continue in a manner similar to what was seen in late 2010.

SPY (S&P 500 SPDRs) NYSE

In the short-term SPY ETF (proxy for S&P 500) chart, we see a bit of a different picture. Here, stocks are at a short-term support line, so it seems that the next short-term move will be to the upside. It's likely however that this move will be somewhat short-lived based on the previously discussed situation on the long-term chart.

Can the above situation be bearish for the precious metals market? Let's take a look at the correlation coefficients between stocks and gold, silver and mining stocks.

correlation matrix

The Correlation Matrix is a tool, which we have developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector.

Two weeks ago we wrote the following on the dependencies between precious metals, currencies and the stock market:

The general stock market simply does not appear too important for gold, silver and the gold and silver mining stocks. (...)

The strong negative correlations between the USD Index and the precious metals continue. The implications appear bullish for the medium term and somewhat unclear for the short term.

The situation changed slightly in the short-term correlations: Gold, Silver and Mining Stocks seem to be correlated moderately strongly with general stock market, whereas the short-term correlations between Silver and USD as well as Mining Stocks and USD seem to have weakened.

In general, the coefficients this week are not very strong with many of them in the range of -0.5. It seems much better to focus on the clearer technical situations in the gold and silver markets as opposed to what we now see in currency and stocks.

Summing up, The situations in the USD Index and the general stock market seem a bit unclear for the upcoming two week period. The USD Index may move a bit higher and a small move to the upside may be seen for stocks as well. Both moves appear to probably be short-lived, however, with stocks likely to soon correct and a subsequent move to the downside seemingly in the cards for the USD Index. This is not expected to have any serious bearish impact on gold, silver or the gold and silver mining stocks.

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Thank you for reading. Have a great and profitable week!

 


 

Przemyslaw Radomski, CFA

Author: Przemyslaw Radomski, CFA

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Gold & Silver Investment & Trading Website - SunshineProfits.com

Przemyslaw Radomski

Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who takes advantage of the emotionality on the markets, and invites you to do the same.

His company, Sunshine Profits, publishes analytical software that anyone can use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem that may never be solved, PR has changed the world of trading and investing by enabling individuals to get easy access to the level of analysis that was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals sector. For that reason it is his main point of interest to help you make the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for professional excellence and ethics for the ultimate benefit of society.

Sunshine Profits enables anyone to forecast market changes with a level of accuracy that was once only available to closed-door institutions. It provides free trial access to its best investment tools (including lists of best gold stocks and best silver stocks), proprietary gold & silver indicators, buy & sell signals, weekly newsletter, and more. Seeing is believing.

Disclaimer: All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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