A correlation and a possible decoupling

In the midst of the hysteria surrounding the plunge in the stock markets Friday, not too many investors may have noticed that the U.S. dollar closed at an all-time low for the second day in a row. The significance of this fact to gold is, as Wendy Ip explains,

The correlation between the US dollar price of gold and the Broad Dollar Index [a measure similar to $USD, the U.S. dollar index] is -0.9075 between the years 2002 to 2007. That is, a rise in the US dollar price of gold is reliably coupled with a fall in the value of the dollar.

This correlation is quite clearly visible, especially since early 2006, in the bottom panel of the weekly chart, which shows the ratio of the gold price to the inverse of the U.S. dollar index.

The relationship continued to hold last week, as gold rose by $14.60, 0r 1.94%, while the U.S. dollar index fell by 0.80, or 1.02%.

On the daily chart, the gold price has mirrored the fall in the dollar particularly closely since the beginning of September. The dollar index looks ready to continue its decline as MACD makes a bearish crossover and RSI threatens to fall below 30.

Interestingly, a (somewhat looser) correlation can also be seen between the recovery of the S&P 500 index since its mid-August bottom and the rise in the price of GDX, the gold-mining ETF, over the same period. This relationship, however, appears to have broken down on Friday, when SPX fell 2.56% and GDX declined 1.27%, almost exactly half as much. As a result, the GDX:$SPX ratio actually rose 1.33%. (Gold itself fell just 30 cents, or 0.04%.)

If GDX manages to show relative strength in the face of declines in the broader stock market, the ETF could increase its appeal to investors looking for a safe haven.

However, even as gold looks relatively healthy — and Ambrose Evans-Pritchard reports that fresh Japanese buying came into play when the gold price broke the psychological barrier of 3,000 yen per gram — GDX appears to be losing momentum relative to gold.

MACD has made a bearish crossover, and both RSI and MACD are showing negative divergences to the GDX:$GOLD ratio. This ratio needs to be watched closely, since, as can be seen in the bottom panel, while GDX has moved in close tandem with gold since the beginning of September, it has led the gold price in the past.

Despite the rhetoric about a "strong-dollar policy," the powers that be in the United States seem to be resigned to the dollar's ongoing decline, if they are not in fact actively promoting it. Martin Feldstein, the well-connected Harvard professor and former chairman of the U.S. Council of Economic Advisers, filled an article in the Financial Times last Sunday with arguments as to why "A competitive dollar is good for America":

The dollar has finally begun its long overdue correction. The dollar’s decline in recent weeks is just a prelude to the much more substantial fall needed to shrink the US current account deficit, running at a nearly $800bn annual rate, about 6 per cent of gross domestic product.