Yesterday we wrote about how bank stocks had led the market’s advance because investors saw that the prospects for rising long-term rates could boost their earnings. Long-term rates tend to rise along with hopes for economic strength – currently bolstered by the latest stimulus bill’s passage through the Senate. But economic strength is not the actual driver for higher long-term bond yields. It is the rise in inflationary expectations that arise from a stronger economy that actually push rates higher.
It raises this question: if markets are incorporating higher inflationary expectations into long-term bond yields, why is gold not responding accordingly?
Gold has always been considered a classic inflation hedge, yet its trading performance at any given time can be idiosyncratic. Sometimes it’s an inflation hedge, and sometimes it’s the “anti-dollar”. Those two are not unrelated, since a weaker currency raises the price of imported goods, but that relationship can be murky. I decided to see how well gold is correlating with these factors, and whether that can give us clues about the future performance of the yellow metal. Consider the following graphs:
SPDR Gold Shares (GLD) vs. iShares TIPS Bond ETF (TIP) with Historical Spread and Correlation – 1 year
The graph above is a one year chart of GLD and TIP, followed by graphs of their arithmetic spread and the correlation of their daily percentage moves. I used ETFs because the terms are more aligned than using individual commodity and bond prices. We can see that the two moved together throughout the early part of the year before diverging last summer. The correlation of .38 is not particularly meaningful.
GLD vs the US Dollar Index (USDX, DXY) with Spread and Correlation – 1 year
In this graph we see a much higher (inverse) correlation between GLD and DXY over the past few months. The value of -0.62 is far from perfect, but is a much more meaningful value then the correlation between GLD and TIP. We can say that over the past few months, gold has acted more as the anti-dollar than as an inflation hedge.
When we look at 5 year charts, however, we see different pictures.
SPDR Gold Shares (GLD) vs. iShares TIPS Bond ETF (TIP) with Historical Spread and Correlation – 5 year
In this comparison of GLD and TIP, we see that they had long periods where they followed each other closely and correlated well. The most pronounced divergence appears to be in the past few months. I interpret that to say that gold acts as a good inflation hedge much of the time, but then unexpectedly does not.
GLD vs the US Dollar Index (USDX, DXY) with Spread and Correlation – 5 year
The same can be said for gold vs the dollar, though it appears to spend longer periods of time with a stronger inverse correlation to the dollar than it does with a positive correlation to inflation.
This is admittedly an incomplete analysis of gold’s relation to inflationary expectations and the US dollar. We would need to examine the relationships over different time periods and how specific economic factors inspired the periods of convergence and divergence. Yet the analysis above brings me to an important conclusion: gold may not be a great hedge against either the dollar or inflation – but it still can play a role in diversifying a portfolio.
Source for all graphs: Bloomberg
The author holds long positions in both GLD and TIP
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