Studies on Gold and its relationship with other financial variables

Abstract: Define as the currency of the last resort, gold has historically been
seen as the ultimate hedge against inflation. However, recent research has
founded that the commodity provides a unique source of diversification to an
investor’s portfolio. This study investigates the long-run relationship between
gold and a set of financial variables based on daily data from January 1990
to June 2016, then use this relationship as a fair value and see what sort of
interpretation we can do with the results.

Link ==> Gold Studies

Gold: how far can the current trend go?

Since the beginning of the year, the commodity market has been regaining strength, and especially gold that has been up 23% since its mid-December low (slightly below 1,050 USD/ounce). As you can see it on the chart below, the recent spike in commodities can be explained by the dollar weakness we have seen over the past five months (DXY index in yellow line inverted vs. Gold in candlesticks). However, I am still convinced that Gold could continue to act as the ‘currency of the last resort’ (i.e. an insurance against the confidence on the monetary system) even if the US dollar is set to appreciate in the long term.


(Source: Bloomberg)

As gold is traded primarily in dollars, many studies have showed that a weaker dollar makes gold cheaper and increases the demand for gold, which in the end pushes the price of the commodity higher. Therefore, Gold and US dollar should be negatively correlated. If we use HS spread analysis function in Bloomberg, we can see that the 1-month (20 Business days) correlation between Gold and DXY index (using the US Dollar index as a proxy of the dollar even if it’s mainly weighed in Euros, pounds and Yen) has been negative for most of the time over the past five years. However, this correlation can sometimes break down and turn positive for a small period of time.


(Source: Bloomberg)

The question now that I am asking myself is to know the positive correlation between US dollar and Gold can last longer than just a week or two.

The reason why I think Gold is set to appreciate in the long term is coming from a long fat tail risk list that gets very concerning. In it, we could find the following events:

  • Japanese crisis in the bond market
  • Banking crisis in China coming from a rise in NPLs and a housing market collapse
  • Corporate default rates soaring in the US high-yield market
  • European Banking crisis

If one of those ‘black swan’ events rises in terms of probability, we would then see a sort risk-aversion environment with more demand for safe haven assets, such as US Treasuries or US Dollars. At the moment, the 10-year and 30-year Treasury yields both trade at 1.74% and 2.57% respectively, and a sudden risk-off sentiment could push LT US yields close to zero.

Academic studies have shown that there exists a cointegrating relation between gold and US real interest rates. If we stick with the assumption that inflation will remain low (i.e. close to zero) in the medium term (2-year period) based on the market’s expectation and that Treasury yields start to crater ‘once again’, an interest for gold could be a good alternative.

Tactical view on XAUUSD

Based on the chart below, it looks like the 50 SMA (purple line) has been acting as a strong support, however the momentum could continue in the future. The next psychological level stands at 1,300 on the upside, any break out could lead towards 1,325 then 1,350. On the downside, I see a strong support zone between 1,220 and 1,250 and could be a good entry point for a long term investment. The risk is if the US Dollar starts to appreciate to quickly based on this week’s FOMC ‘hawkish’ minutes with the market now starting to price at least a couple of rate hikes for 2016. For those looking for a more ST investment, a good psychological support on the downside to set up your stop stands below 1,200.


(Source: Bloomberg)