Some say that the POG can be anticipated as an opposite move to the Dow. The Dow, of course, is an index that tracks the movement of some prominent U.S. stocks and is thus somewhat representative of the equity market. If this equity index goes up, the POG is supposed to go down, and vice versa.
However, it seems that a more precise reverse correlation exists with the U.S. dollar. The POG is, after all, priced in U.S. dollars. Thus, for example, if the value of the U.S. dollar goes down, you need more of those dollars to buy the same amount of gold, meaning the POG goes up; conversely, if the U.S. dollar goes up, the POG goes down. It's a direct, mathematical relationship. No one should be surprised by it, nor should we forget about it.
We shouldn't forget about it because, as shown in the following charts, the swings in the U.S. dollar have been so dramatic that it seems to have been the primary factor affecting the POG.
To understand the following charts, it should be understood that the US$ is often valued by comparing it to a basket of other currencies, those of its primary trading partners, such as Europe and Japan. This is sometimes referred to as the US$ index; further details here www.nyce.com and here http://www.federalreserve.gov/releases/H10/Summary/. As the US$ becomes stronger as compared to those currencies, this index goes up; as the US$ becomes weaker, the index goes down. Here is a chart of that index overlaid with the POG and observe the relationship.
Note the same inverse relationship in this close-up look at the last 3 months or so.
As we can see, when the dollar has gone up, the POG has often gone down, and vice versa. Moreover, those price swings have been dramatic. In fact, if we had a chart going back further, we could see that the US$ had a huge rise from 1981 to 1985, nearly doubling. Over that same time period, gold was approximately cut in half. Then, from 1985 to 1988, the US$ was cut in half, and gold just about doubled. So both of those moves in gold were largely explained or matched by opposite movements in the dollar.
You can also notice the correlation on a shorter term basis if you were to try the convenient intra-day comparison available here:
At that link, you can also draw a comparison with the Dow. For example, shown below are comparisons of the Dow with both the POG and the US$ (captured just a few days after the first two charts above).
You can see that, instead of the Dow, the correlation between the US$ and the POG is much stronger, after all, it's mathematical.
There are, of course, some correlations between the Dow and the POG. For example, sometimes when we see the Dow drop, investors are taking their money out of equity stocks due to some sort of economic or geopolitical risk, and moving that money to a safer investment, such as gold. Any increase in the risk of terrorism or war seems to be reflected by a decrease in the Dow and a corresponding increase the price of gold, and without any necessary effect on the dollar. Some examples are as follows:
-The Dow dropped and the POG went up after the tragic events of Sept 11, 2001; see point (X) on the 5 year chart above.
-They both then slowly returned to their previous levels as the fear subsided.
- The Dow dropped and the POG went up when there have been warnings of further attacks, such as in the days leading up to the first anniversary of September 11; see point (Y) on the 3 month chart above.
But otherwise, in late October and in November, both the POG and the Dow are MOVING IN THE SAME DIRECTION, in this case up. So the inverse correlation with the Dow fails us. Instead, we again see the POG better explained by movements in the Dollar as follows:
-Looking first at point (R) on one of the above charts, we see both the Dow and the POG starting to rise. The main explanation is that many investors anticipated the recent drop in U.S. interest rates (which ultimately occurred in early November 2002). It is commonly known that, if the U.S. lowers its interest rates for its treasury bills and bonds, investors are less likely to keep their funds in those investments; they move some of those funds to other investments, such as equities, (which is good for the Dow), and some are moved to foreign treasury bills (which ends up being bad for the US$, which is in turn good for gold). Thus, in late October, at point (R), we see both the Dow and the dollar rising together rather than in opposite directions.
- Then, in early November 2002, Iraq faced a deadline to comply with weapons inspections; the US$ dropped while the POG rose; see point (S) on the chart above. Then, when compliance was announced, the US$ went back up while the POG went back down. If you now look at the above 3 month chart which includes the DOW, you'll see (or perhaps remember) that the Dow was all over the place during this time, with little correlation to the POG. Again, the POG was better tracked by the dollar, or at least some combination of the Dow and the dollar.
So next time there's an event, or you anticipate an event, that might affect the Dow, it might not inversely affect gold; the affect of that event on the dollar must also be considered. As a wild example, some further bad news out of Japan might suggest a drop in the Dow, but the same news might hurt the Japanese yen, which could strengthen the $US, which would thus hurt the POG or at least temper its rise. So again, the price of gold might not necessarily follow the Dow.
Yours sincerely,
Joe Investor
Copyright © T. Bortolin, November 2002
Toronto, Canada
T.Bortolin is a private investor and student of the financial markets. He lives in Toronto, Canada and can be reached at bortolin@pathcom.com
Nothing in this article is intended as investment or professional advice or as a recommendation to buy or sell anything. Each reader is solely responsible for doing their own due diligence or obtaining their own professional advice before making any investment. Any stocks mentioned in this article are for illustration purposes only. All information is taken from sources believed to be correct and complete.