STOCKCHARTS ADDS NEW CORRELATION COEFFICIENT INDICATOR WHICH IS ESPECIALLY HELPFUL IN INTERMARKET WORK -- IT CONFIRMS POSITIVE CORRELATION BETWEEN STOCKS AND COMMODITIES AND NEGATIVE CORRELATION TO BONDS AND THE DOLLAR
IT QUANTIFIES INTERMARKET RELATIONSHIPS... The Correlation Coefficient which has just been added to the Stockcharts.com indicator list measures the strength of a relationship between two markets. That relationship can be positive or negative. For example, a coefficient of +1.0 means that two markets are perfectly correlated which means they trend in the same direction all of the time (which is very rare). Conversely, a correlation of -1.0 means that they move in the opposite direction 100% of the time (also very rare). Markets generally swing between those two extremes. Generally speaking, a plus number shows positive correlation (same direction) while a minus number shows negative correlation (opposite direction). The higher those numbers become in either direction, the higher the correlation (positive or negative). This indicator is especially helpful in intermarket analysis which is based on the relationships between markets. It not only allows us to put an actual number on the strength of those relationships, but allows us to tell when the relationship is strengthening or weakening. Chart 1, for example, compares the Dow Industrials (price bars) to the CRB Index (brown line) over the last six months. The correlation coefficient line (below chart) stands at +0.79 as of yesterday's close. That's a pretty high number and shows a very strong correlation between the two markets. In this example, I'm using a 20-day period to measure the correlation which is useful in measuring short-term swings. [To create Chart 1, click on the Correlation Coefficient and type in the symbol to be compared and the time period ($CRB,20). You can change the number to measure longer or shorter time periods]. The falling black line during May and early June shows the relationship weakening as commodities fell faster than stocks (down arrow). The line started rising in late June as both markets started bouncing together (rising arrow). Chart 2 shows that stocks (price bars) and bond prices (green line) have a negative correlation of -0.49 using the same time span. Chart 3 shows that stocks (price bars) and the Dollar Index (green line) have a negative correlation of -0.46. That simply confirms the fact that stocks and commodities have been trending together, and that both are trending in the opposite direction of bonds and the dollar. We can see that by comparing the charts. The Correlation Coefficient, however, elevates the study of those intermarket relationships to a new and more useful level. That opens up a number of interesting ways to trade the markets.
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Chart 1
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Chart 2
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Chart 3
LONG-TERM COMPARISON OF GOLD AND GOLD STOCKS... Chart 4 compares the price charts of gold (price bars) to the Market Vectors Gold Miners ETF (solid line) over the last five years. You can see that they generally trend in the same direction. That's confirmed by the correlation line below the chart using a time span of 20 weeks. The correlation between gold and gold stocks has been very strong (above .75) for most of that time. The Correlation Coefficient, however, fell sharply this spring as the two markets temporarily decoupled. Those short-term aberrations usually don't last for long. The daily bars in Chart 5 compare GLD (price bars) to the GDX (solid line) over the last six months. You can clearly see the decoupling between gold and gold stocks taking place from April to mid-June either by looking at the chart or the falling Correlation Coefficient (below chart) which hovered around zero for a couple of months (meaning little or no correlation). The black line starting rising again in early July as both markets started rising together and now stands at a very high value of 0.96. The rising CC line in early July suggested that it was a good time to get back into gold stocks. But there's more. It also helped us to find out which gold stocks.
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Chart 4
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Chart 5
BUY GOLD STOCKS WITH HIGHEST CORRELATIONS TO GOLD ... Gold continues to hit new record highs while most gold stocks are just trying to catch up. Another way to utilize the Correlation Coefficient is to look for gold stocks with the highest correlation to gold. A few weeks ago I showed three gold stocks that demonstrated superior chart patterns with strong relative strength. It just so happens that those three gold mining leaders also have the highest correlation to bullion. The three charts below show Kinross Gold (KGC), Goldcorp (GG), and Yamana Gold (AUY) with high Correlation Coefficients of 0.82, 0.81, and 0.69 respectively. That also made them strong candidates to benefit from the rising gold price. Virtually all gold stocks now show positive correlation to gold, but with lesser numbers. They include IamGold (0.65), Barrick Gold (0.59), and Newmont Mining (0.64). In these three examples, I've used a longer time span of 50 days to smooth out the short-term swings and reveal a longer-term trend. Chart 6 shows the CC line for Kinross turning up in April and becoming positive in mid-June. That made it a likely gold leader. The CC line for Goldcorp (Chart 7) turned positive in late June. Chart 8 shows the CC line for Yamana Gold doing the same. Investors looking to capitalize on the rising gold trend (above charts) could have used the Correlation Coefficient Indicator as another tool to help find those gold leaders. I'll be writing a lot more about the Correlation Coefficient in future messages. I'm very excited to add it to my intermarket tools. In the meantime, play around with it. I'm sure you'll find it very useful as well.
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Chart 6
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Chart 7
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Chart 8
INTERMARKET TRENDS ARE POSITIVE... The intermarket correlation trends described above are very evident in today's markets. And they're positive. Chart 9 shows the Euro rising back above its (blue) 50-day average after bouncing off its 200-day line. That means that the dollar is falling which is good for stocks and commodities. Chart 10 shows the DB Tracking Commodity ETF (DBC) close to exceeding its June intra-day high at 30.68. Stocks are rising along with commodities. Chart 11 shows the S&P 500 climbing more than 1% and safely above its 50-day line. Not surprisingly, Treasury Bonds are the day's losers. Chart 12 shows the 20+year T-Bond iShares (TLT) falling below its 50-day line after failing to exceed its June high. That all makes perfect sense. When stocks and commodities rise together, the dollar and bonds usually fall.
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Chart 9
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Chart 10
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Chart 11
