Gold Should Whip Itself Back Into Shape

by Serge Berger | December 10, 2012 9:00 am

Ever since the first government-sponsored rescue package was thrown at the market in 2009, correlation among asset classes (stocks, commodities, currencies, fixed income) has increased.

The terms “risk-on” and “risk-off” were coined to describe markets’ appetite for risk in general. As such, investors have not distinguished much between asset classes — when risk was on, they tended to buy anything from equities to commodities and bonds, whereas during risk-off periods, everything was sold off. The level of correlation would vary from week to week, and at times even went inverse for a handful of months before mean-reverting … but looked at as a whole since 2009, correlation is up from years prior.

Such is the case when we consider the correlation between stocks and gold.

The following chart of the SPDR S&P 500 ETF (NYSE:SPY[1]) vs. SPDR Gold Shares (NYSE:GLD[2]) shows the correlation and relative performance of stocks and gold looking back to late 2004. Since spring 2009, when stock markets bottomed and governments increased their market interference, stocks and gold have traded higher in a relatively tight relationship. Each time stocks and gold deviated too much from each other, they eventually came back together.

A closer look at the relationship shows that while the S&P 500 has rallied strongly off the recent Nov. 16 low, gold has lagged badly and in fact trades lower than it did on that date.

This in and of itself is not very telling because, as discussed above, such divergence can last and widen for several months. However, if we consider the bullish construction of both the gold chart and that of the S&P 500, it could give us reason enough to look for a tightening of the current spread and a re-coupling of the correlation.

As an aside, the same recent divergence can be seen in Europe when we chart the Eurostoxx 50 stock index vs. gold since early November.

The chart of gold (via GLD) remains in an uptrend where dips might get bought. After a significant low in late May, the stock had an equally important breakout above resistance in August. After bumping up against resistance near $174, the ETF has corrected but remains constructively positioned for renewed upside.

The S&P 500 too remains well-positioned for further gains through the seasonally strong November-February period. The uptrend since the beginning of the 2011 “Santa Claus rally” on Dec. 19 remains intact, and price resistance near $143 looks susceptible to be broken before year-end.

Given the recent inverse correlation between the S&P 500 and gold, in addition to the bullish setups in both individual charts, it seems reasonable to expect an outperformance of gold in the coming weeks.

Serge Berger is the head trader and investment strategist for The Steady Trader[3]. Sign up for his free weekly newsletter here[4].

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