Lately, we’ve been bullish on the dollar here at the Market Minute…
And because of the inverse relationship between dollar sensitive commodities like gold and agriculture, we’ve also been calling for lower prices in those sectors.
In late May, Jeff Clark called for a short-term bounce in the dollar. And since then, gold fell 3.25% and the Bloomberg Agricultural Commodity Index (BCOMAG) fell 5%.
What may seem puzzling though, is how quickly we resumed our long-term bullish outlook on gold.
On Tuesday, I even mentioned how factors other than the dollar will ultimately send gold above last year’s highs:
“The main factor that will surpass any other macro forces on assets like bitcoin and gold is the ever-falling real rate. That’s why gold will ultimately break last year’s high of $2,075/oz, and head towards $2,400 from there.”
It may seem contradictory and confusing that we can be both bullish on the dollar and gold at the same time… especially given its historically inverse relationship.
So today I want to explore this relationship a little deeper and point out how both can rise at the same time…
The Relationship Isn’t Absolute
There are many reasons that contribute to gold’s inverse relationship to the dollar, but mainly it’s because gold is a non-productive asset. As such, gold serves as a store of value. And since it’s priced in dollars, it naturally falls when the dollar rises – and vice versa.
This relationship is seen in the chart below. The chart uses a statistical tool called correlation to show how two assets are connected. This measures how in sync two assets are trading. Correlation ranges from 1 to -1.
A correlation of 1 occurs when one asset moves, either up or down, and the other asset moves with it in the same direction. On the flip side, a correlation of -1 occurs when two assets move perfectly in opposite directions. A zero correlation just means there’s no linear relationship.
Take a look at this chart…
As you can see from the chart, gold and the dollar spend most of their time negatively correlated, or below zero. That means they tend to trade against each other. In fact, since 2007, the average has been -0.45. That’s pretty reliable… usually.
Although this relationship holds most of the time…it’s not absolute. The lower end of the correlation between gold and the dollar is around -0.80.
Historically, that’s about as far as they will trade opposite each other. And that’s exactly where the correlation is right now. From here, it’s highly unlikely that it’ll go further.
So, even if the dollar goes higher from here, historically it won’t have the same effect… meaning that gold will be affected by other dynamics in the market such as interest rates, the rate of inflation, and policy changes from the Fed.
So with the real interest rate still negative and trending down… this recent dip in gold sets up a great buying opportunity as it heads towards last year’s high.
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Right now, prices are re-testing the 200- and the 50-day moving averages (MA).
Just look at this chart…
This should provide strong support… especially since the shorter-term 50-day MA is about to cross the 200-day mark. That’s what’s known as the “golden cross.”
Traders love that setup… and the media loves it even more. So before mainstream headlines will undoubtedly begin touting this golden cross… We’re already adding gold to our portfolio and looking to add more on the way up.
Ultimately, I predict gold is set up to trade above last year’s high and head towards $2,400, as the most important trade of the year continues to be commodities.
Regards,
Eric Shamilov
Contributing Editor, Market Minute
Reader Mailbag
Will you be buying the gold dip on the negative Fed reaction? Does the “golden cross” convince you of a positive move higher?
Let us know your thoughts – and any questions you have – at [email protected].