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Tuesday, March 21, 2017

What correlates the most with gold prices?

There are many theories floated around online about which variable affects gold prices the most. Some say interest rates are important because gold doesn't provide yield, so high interest rates will cause gold to fall. Still others claim that gold is more like a currency that is most affected by the dollar, or it is rises with volatility.

No need to speculate further about which argument carries the most weight. I ran a correlation on GLD versus a number of popular instruments to find out which had the most correlation. I ran correlations for the S&P 500, 30 year treasuries, the VIX (volatility) and the US dollar. Which won out?

According to the chart below, the most consistent correlation was an inverse correlation with the US dollar. When the US dollar rises, gold falls. When it falls, gold rises. There were times when gold rose with the S&P 500. Other times it fell. The same was true of bonds and volatility. It appears, based on this evidence, that gold *is* most like a currency, and if you can predict which direction the US dollar is going, you are likely to win big in gold. However, if you can successfully predict the US dollar, perhaps it would be simpler to just trade the US dollar!


Update:

A reader suggested I look at correlations to real interest rates. I pulled the correlations for 5, 10, and 20 year rates. They all look roughly the same. While there is a tendency for there to be a slight negative correlation at times with interest rates, it isn't nearly as consistent as the correlation with the US dollar. I used $GOLD to get more data this time, and can definitely confirm that the US dollar is the main driver for the price of gold.


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5 comments:

  1. RandomPersonMarch 22, 2017 at 7:15 AM

    Try Real Interest rates (5yr/10yr/20yr/30yr)

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    Replies
    1. Jeffrey RobinsonMarch 22, 2017 at 7:18 AM

      I will post that info soon. Thanks for the suggestion.

      Delete
  2. RandomPersonMarch 22, 2017 at 10:47 AM

    Frank Holmes has written several articles on Real Interest Rates and the correlation to Gold Prices (Google 'Frank Talk'). The following was taken from one of his articles:
    Real Interest rates are calculated as follows:
    5-yr Treasure Yield - Inflation = Real Interest Rate
    Example:
    March 2013
    0.88 - 1.50% = -0.62 Price of Gold Up $1,614
    December 2013
    1.74% - 1.20% = +0.54% Price of Gold Down $1,187
    March 2014
    1.53% - 1.60% = -0.07% Price of Gold Up $1,350

    For gold, the real fuel lies in negative-to-low real rates of return. Historically, the gold price rises when the inflationary rate (CPI) is greater than the current interest rate. Similarly, when real interest rates go above the positive 2-percent mark, you can expect the gold price to drop.

    I use the following site to monitor the real rates updated daily EOD
    http://www.multpl.com/5-year-real-interest-rate/

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    Replies
    1. Jeffrey RobinsonMarch 22, 2017 at 11:58 AM

      It's true I didn't look at real rates, just the literal rate quote. Perhaps the multicollinearity happens due to the relationship between CPI and the US Dollar. I still would argue rates matter less than the dollar. The rates may lag movement in the US dollar (i.e. higher dollar, higher rates). I'd have to look at that more closely. I'm not sure if that author looked at multicollinearity to determine the root cause of why higher rates might force gold down.

      Delete
  3. RandomPersonMarch 22, 2017 at 12:57 PM

    The relationship between the dollar and gold is transitory. It can change at a whim.... it works when it works and when it doesn't it doesn't. Old timer Forex folks tell me that the Japanese Yen works better while others suggest the Swiss Franc... Negative real rates has had a better track record for me... I watch all and maintain an EW count on Dollar and Yen....

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