Fireworks Ahead For Gold?

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There are many odd correlation divergences taking place in the gold market, many of which may redress themselves in the form of mean reversion if historical patterns play out. Looking at it from a fundamental perspective, a Macquarie report sees little shift in central bank demand and thus anticipates that any change in the supply and demand equilibrium will need to come from institutional investors. But if the correlation divergences are addressed in markets, it could lead to a tailwind for gold.

With a weaker than anticipated jobs number reported Friday – the US economy added 103,000 jobs were added in March, well shy of the 188,000 expected – gold shot up nearly $6.30 per ounce, trading near $1,333 per ounce.

After trending higher from a December low to a January high, the price of gold has been mostly range-bound since. Even with Friday’s boost, it remains in the middle of its trading range amid certain correlation divergences.

The oil/gold ratio is pointing to a correlation range at the outer edge of its historical range, Bloomberg Intelligence pointed out. One ounce of gold currently buys 21 barrels of oil, significantly less than the two-year average of one-ounce buying 25.4 barrels.

Another correlation breakdown is occurring in the ratio between gold and real interest rate yields. Top Down Charts points out the 5-year real yield, the US 5-year Treasury yield minus the US 5-Year Inflation SWAP, has meaningfully inverted. Since the end of 2017 real yields have spiked while the price of gold has, likewise, risen. Typically, these assets have an inverse correlation.

Macquarie looks at the fundamental supply and demand, pointing to 2017 that saw physical demand fall by 4% and supply fall 3% on a year over year basis. They don’t see “price fireworks” occurring as a result, with only small changes occurring in their fundamental forecast for 2018. Rising gold prices in light of these factors portend well for the price of gold in the future, as does a potential reversion to the mean on many of the correlation ratios if this should occur.

Macquarie is only “mildly positive” on the price of gold. To see significant price increases, institutional investors will need to be a force in demand growth. On the supply end of the market, mining production could fall over the longer term, both of which could help boost prices.

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About the Author

Mark Melin
Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com

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