Gold Stocks, Interest Rates and the US$

Here is an extract from commentary that was posted at www.speculative-investor.com on 14th November 2002. 

In recent commentaries we've spent a lot of time discussing how interest rates influence the prices of gold stocks. In particular, we've explained that it is the level of long-term interest rates relative to short-term interest rates (the 'yield spread'), rather than the absolute level of long-term interest rates, that is of greatest importance to the prices of gold stocks. 

When we talk about the 'yield spread' we are referring to the yield on the 30-year T-Bond minus the yield on the 13-week T-Bill. Over the period from 1982 to the present day the correlation between the yield spread and gold stock prices (as represented by the Barrons Gold Mining Index) was +0.29. This is a significant correlation and, in rough terms, implies that the yield spread and gold stocks trended in the same direction about 65% of the time. In recent years, however, the relationship has become even stronger. In fact, since the beginning of 2000 the positive correlation between the yield spread and the Barrons Gold Mining Index (BGMI) has been an extremely-high 0.77 (implying that the 2 sets of data have trended in the same direction about 88% of the time). 

We can't be sure that the higher correlation over the past 3 years means that there is now a permanently-stronger relationship between the yield spread and the gold sector of the stock market. However, since the relationship has been so strong during recent years it is certainly worth paying close attention to the behaviour of the yield spread when attempting to assess the gold sector's risk/reward ratio.

While the correlation between the yield spread and gold stocks has varied widely over the past 30 years, the inverse correlation between gold (and hence gold stocks) and the US$ has consistently been strong since gold and the Dollar were officially de-linked in the early-1970s. This is the case almost regardless of what period we select. For example, over the past 30 years the correlation between the SF/US$ exchange rate (the number of US Dollars per Swiss Franc) and the gold price was 0.79, whereas the correlation between the two over the past 12 months was 0.74. In other words, the correlation between gold and the Dollar over the past 12 months has not only been very high, it has been almost perfectly in line with the long-term average.

The below chart shows how the Barrons Gold Mining Index, the SF/US$ exchange rate and the yield spread have moved in synch with each other since the beginning of 2000. (Thanks to Mark L for his work to compile the Barrons Gold Index data)

We are certain that the gold market is manipulated and we are quite sure that some of the world's major central banks and governments have a hand in this manipulation. However, it is clear that the manipulation has not prevented the inter-market relationships that have worked well for the past 30 years from continuing to work well. Therefore, although it is certainly possible that the gold price could move higher for reasons that have nothing to do with the US$, it is highly improbable.

At this stage the US$ appears to be headed much lower. This, in turn, is a good reason to be very bullish on the prospects for gold and gold stocks. When bond prices fall, thus causing the yield spread to widen, this will create more upward pressure on the prices of gold and gold stocks.

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