Intermarket relationships between equities and metals markets

This week, the outlook on the coming week is exceptionally not the main focus of this blog. Over the past week, we received some inquiries from Bloomberg and Reuters to comment on market movements of gold and industrial metals. The journalists were a little surprised that the price of gold rose, though, investors have once again leave the safe havens. It is a wide spread view that gold is a crisis metal. Too often, we read that gold and equities were not correlated, so that a simultaneous recovery of gold and stock markets, as in the previous week, surprises many market observers. Therefore, in this blog posting, we focus on the interactions between equities and metals markets as well as the status of gold as a safe haven.

Gold has the function of a safe haven for investors, but not in any crisis situation. It is essential, what kind of crisis it is, whether the price of gold also increases in a flight to a safe haven. Gold is then strongly in demand if investors fear the loss of purchasing power of their currency. The relationship between the gold price in USD and the inflation rate in the U.S. is indeed weak, but not between the gold price and the momentum of inflation. Rising inflation rates are positive for the gold price, while a trend of lower inflation rates leads to falling gold prices. It is also observed that the gold price rises normally, if the external value of the U.S. dollar falls (dollar weakness), and a firm dollar is negative for the gold price.

There is also often a flight into gold when it comes to a crisis of the financial system. However, in such a crisis, gold prices could also be falling, namely when other asset prices plunge, and investors, who partially funded their positions through credit, need to sell gold to offset the losses in other assets. Then gold can also be dragged down despite a crisis situation. However, This should not have been the case in the third week of May, given the fact that gold holdings by the largest gold ETF, the SPDR Gold Trust, were still increasing.

Gold is indeed secure against a loss by atrophy, but not against a loss of value due to price fluctuations. It should therefore come as no surprise that investors consider gold as a risky investment. If the risk aversion of investors increases, this is also negative for the risky investment gold. The volatility indices for the equity markets, as the VIX in the U.S. or the VDAX in Germany, are a common measure of risk aversion. When these indices rise sharply, it is usually negative for gold. The stock market is a leading indicator for economic development, though not very reliable one. Nobel laureate Paul Samuelson once mocked that the U.S. stock market has properly anticipated nine of the last five recessions. If stock markets panic, then investors almost reflexively flee in government bonds as a safe haven, but not in gold. This reflects the sharp decline of yields for U.S. Treasuries and German Bunds. Falling stock indices signal a weaker economic activity, this is also a negative signal for the demand for industrial metals, so that even this group of commodities is pulled down by falling stock indices.

Towards the close of trading before Pentecost, the U.S. stock market had recovered significantly from the lows recorded at the end of trading in Europe. This development led to a stabilization of stock markets also in Asia and Europe at the start of the previous week. Markets came again a bit under pressure in the short term after the FT reported that China would turn away from European government bonds. But the denial from China then triggered a rally of stocks, precious and industrial metals. After the close of trading in Europe on Friday, the rating agency Fitch has announced that it lowers the rating of Spain to AA+ from AAA because the austerity measures would lead to lower growth. Too bad, the rating agencies have threatened to downgrade Spain if no measures were taken to reduce the budget deficit. One could get easily the impression that Spain should be downgraded, no matter on what grounds. For the equity markets this could trigger a new wave of falling prices, which should then also have the negative impact metals markets.