Gold And Stocks Headed Lower

GOLD AND STOCKS HEADED LOWER – NO CORRELATION

Gold and stocks are moving south together; but they are not correlated. Nor, are they inversely correlated, as some gold enthusiasts claim.

Reference to gold as a safe haven has some investors buying gold to hedge against a stock market crash. It is almost as if gold has become a pseudo defensive stock.

It seems investors actually expect gold’s price to go up when the stock market goes down; and vice-versa.

If that were the case, how do you explain the extended periods when both moved together; or the price action of gold relative to stocks in the past four days? Gold currently is lower in price than it was before stocks tumbled nearly 4000 points.

For five full years, from the fall of 2002 until late 2007, both stocks and gold prices moved in tandem. During that period, stocks were up eighty percent. Certainly no need for a defensive posture, right?

Crazy thing is, the price of gold was up too. And much more than stocks. At the end of the five years, gold’s price had increased by more than double.

The next year, in 2008, stocks and gold turned about face and marched together in the opposite direction. Both stocks and gold prices lost more than thirty percent.

So why does the theory persist that gold and stocks move inversely?

Probably, it has its origins in the price action of stocks and gold during the decade of the 1970s.

Gold ‘s price went up throughout the 1970s reflecting a dramatically weaker US dollar. Some of the price increase was catch up for several decades of lost purchasing power in the US dollar. Part of the increase was due to anticipation that the US dollar would continue to weaken much more.

Stocks, on the other hand, underwent several unsuccessful attempts to crack the 1000 level for the Dow Jones Industrial Average, followed by agonizingly long declines. During 1969-74, the Dow Jones Industrial Average dropped forty percent.

So, is there correlation of some kind, positive or negative, for stocks and gold? No.

NO CORRELATION BETWEEN STOCKS AND GOLD

In order for correlation to exist, there must be fundamentals that directly connect the two items being compared. For example, there is a possible correlation between localized bad weather and crop failures. But how do you predict the timing and extent, or the effects, to a degree that can be profitable?

And there certainly is a correlation between the price of labor and materials vs. the finished cost of building a new home. But there is no correlation between the price of labor and materials vs. the number of new housing starts.

Stocks and gold prices move independently of each other for different reasons.

Lower stock prices over an extended period of time are usually the result of poor economic conditions.

Gold’s price is not affected by economic conditions. The price of gold is a reflection of the changing value (purchasing power) of the US dollar, which is a financially specific issue, not an economic one. Gold’s higher price over the past century correlates to the ongoing decline in the value of the US dollar, not changing economic conditions.

Recently, some have said that in order to have a huge burst upwards in gold’s price, there would need to be a collapse in the stock market. Not so.

The only thing necessary for a much higher gold price is a much weaker US dollar. Without a significantly weaker US dollar from current levels, you won’t see significantly higher gold prices.

Another unrealistic expectation is that a credit collapse and huge drops stocks and bonds, leading to a depression, will send gold soaring in price. No, it won’t.

First, huge price drops won’t be limited to stocks and bonds.  Anything denominated in dollars will be affected, including real estate and commodities; and, yes, gold.

That is because the conditions resulting from a credit collapse will lead to radically bad economic conditions accompanied by deflation. (see Gold Prices – Inflation vs Deflation ).

DEFLATION MEANS LOWER GOLD PRICES

Deflation is characterized by a contraction in the supply of money. Hence, each remaining unit is more valuable; i.e., its purchasing power increases.

Regardless of the Fed’s attempts to avoid it, deflation is a very real possibility. An implosion of the debt pyramid and a destruction of credit would cause a settling of prices for everything – stocks, real estate, commodities, etc. – worldwide – at anywhere from 50-90 percent less than current levels.

The end result would be a very strong US dollar. And a much lower gold price.

IF and WHEN gold prices move dramatically higher, it will only happen in conjunction with a correspondingly weaker US dollar. Until that happens, all bets are off.

(also see Gold vs Stocks: Ratios Do Not Imply Correlation)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!