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What is Gold Telling Us About the Markets


That is the symbol for gold as it sits on the Periodic Table as element 79. The name "Au" derives from the Latin term "Aurum," which means shining dawn.

This soft, shiny metal has fascinated humanity for more than five thousand years and STILL captivates the attention of many investors.

Historically, we have looked at gold through the same lens as Warren Buffett. In his 2011 letter to Berkshire Hathaway shareholders, he said…

 "Gold … has two significant shortcomings; it is neither useful nor procreative. True, gold has some industrial and decorative utility. Still, the demand for these purposes is limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

We agree. We don't think that gold has any real fundamental value.

Looking out to the future, we have some legitimate concerns about the demand demographics.

With the rise of cryptocurrency and the digitalization of the world overall, we think future generations may be more interested in these areas.

If fewer folks believe in the value of gold – and with few industrial uses – we think it could be a problem.

Despite our skepticism, however, recently, we have been warming up to gold.

These demographic issues could take decades to develop and might never happen. Most importantly, trust in governments and their ability to steward the economy and their currencies is at an all-time low and going lower. Justifiably so!

Regardless of the debate over the “value” of gold, we can use the PRICE of gold to tell us something about the markets.

We recently read a report from one of our favorite research firms, Bespoke Investment Group and they pointed out that the speed and magnitude of the recent move in gold is extremely rare.

One way to look at this is to see the distance of the current price from the 50-day and 200-day moving averages. You can then look at that distance and put it into percentiles.

Recently, gold was in the 99th and 97th percentile of extension from the 50-day and 200-day moving averages, respectively. To put this in perspective, there have been only 267 trading days (out of almost 11,000) since 1982 that gold has been THIS extended. This is EXCEEDINGLY rare…

What does this rapid and robust move in gold tell us about the stock market?

A situation so rare in such a significant asset class (the market cap of gold is almost $16 trillion versus $44 trillion for the S&P 500) must have some message in it.

Here is a chart showing those rare periods in red and put on top of a chart of the S&P 500…

via Bespoke Investment Group

Taking a quick look at this chart, despite this signal being so rare, I see that it doesn't seem to portend very much for the stock market.

Given the association of risk aversion around gold and that investors buy it when they are fearful, you would expect that these kinds of moves in gold would be a bad sign. From the chart, it looks like the opposite.

Here is a chart putting the price of gold on top of the price of the S&P 500 since 2000…

The price of gold is the blue line, and the S&P 500 is in white. Looking at the charts, they look like they are correlated.

When the S&P 500 is in a nice uptrend, gold also tends to do quite well. In fact, gold has an 80% correlation across the most recent decade to the S&P 500.

Why, then, do investors flock to gold to diversify their portfolios?

The reality is that during “risk on” periods, the price of gold tends to go up with other risk assets. That is what is happening now.

Other risk assets – the S&P 500, bitcoin, and other commodities – have been rallying sharply, and it looks like the price of gold decided to join the property.

The value of gold, though, to investors is when we move to a “risk off” environment.

In that case, it is much LESS correlated to the stock market. Sometimes, it is not correlated at all during market crashes.

The nature of the lack of correlation, though, is quite interesting.

It is not that gold goes UP when the stock market (and other risk assets) crash; it doesn't go down or down much less!

Historically, gold prices rallying strongly have pointed to a STRONGER upcoming environment for the stock market and other risk assets.

If the long history of this relationship continues to hold, we think that the recent rapid rise in the price of gold is a GOOD thing for the stock market. Even though this might be contrary to what investors might initially think…

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