ALTHOUGH FALLING DOLLAR IS GOOD FOR GOLD, GOLD NEEDS TO RISE AGAINST ALL CURRENCIES TO RESUME ITS BULL TREND -- DOW/GOLD RATIO NOW FAVORS STOCKS FOR FIRST TIME IN A DECADE -- FALLING GOLD/COPPER RATIO IMPLIES ECONOMIC OPTIMISM
FALLING DOLLAR IS GOOD FOR GOLD... During the Stockcharts' New York seminar over the weekend, we got into a discussion of gold. One of the attendees asked why I remained negative on gold's long term trend in the face of a declining dollar. I responded that there were other intermarket factors that were working against gold, but didn't have time to elaborate on them. I'm going to use today's message to examine those intermarket influences more closely to explain why I believe that the gold boom of the last decade has ended. Chart 1 is the chart that started the discussion by showing the Dollar Index (green line) falling to a seven-month low last week. Gold prices jumped as a result (orange line). Let's take longer look at why that relationship is important.
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Chart 1
BUT GOLD NEEDS TO OUTPACE ALL CURRENCIES, NOT JUST THE DOLLAR... Chart 2 shows that the major bull market that started in gold during 2002 started just as the Dollar Index was starting a major decline. So dollar direction is important to the trend of gold. But it's not that simple. When gold is in a major bull market, it's not enough for it simply to rise in dollar terms. It has to also rise in foreign currency terms. In other words, gold prices rise faster than all currencies. Chart 3 compares the price of gold (black line) to the world's strongest foreign currencies between 2002 and 2011. Although all of them rose, gold's 409% gain dwarfed the strongest currency (the Aussie Dollar) which gained 100%. Chart 4 plots a "ratio" of gold against those leading currencies. Notice that all foreign currencies fell versus gold during that decade. That's what a gold bull market looks like. Unfortunately for gold, it is no longer doing better than foreign currencies.
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Chart 2
Chart 3
Chart 4
GOLD IS NOW UNDERPERFORMING FOREIGN CURRENCIES... Chart 5 compares gold (black line) to five of the strongest foreign currencies over the last two years. The strongest currencies have been the pound, Canadian dollar, Euro, Aussie Dollar, and Swiss Franc. None of them actually gained ground during those two years. But all five did better than gold (which lost -27%). Chart 6 shows that more clearly by plotting "ratios" of those currencies relative to gold. Notice that all of their relative strength ratios are rising versus gold. That's not a bullish sign for bullion.
Chart 5
Chart 6
EVEN THE YEN IS DOING BETTER THAN GOLD ... The weakest currency over the last year has been the Japanese yen. Chart 7 plots a "ratio" of the yen divided by gold, and shows that even the yen has been rising faster than gold since the start of year. Keep in mind that gold has a dual role as a commodity and a currency. Over the last decade, gold was the strongest currency. It isn't anymore. It was also the world's strongest commodity. It's no longer that either (more on that shortly).
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Chart 7
DOW/GOLD RATIO NOW FAVORS STOCKS ... Another headwind for gold is coming from the stock market. An inverse relationship usually exists between gold and the stock market. During the inflationary 1970s, gold soared while stocks fell. During the disinflationary era between 1980 and 2000, gold fell while stocks experienced a major bull run. The stock market peak during 2000 started a "secular" bear market in stocks. During that deflationary decade, gold became the world's strongest asset. That is no longer the case either. Chart 7 plots a ratio of the Dow Industrials divided by the price of gold (orange line) compared to monthly bars for the S&P 500. Notice that the stock/gold ratio started dropping during 2001 and continued to drop until 2011. During those ten years, gold did much better than stocks. The Dow/gold ratio, however, bottomed during 2011 and has risen to the highest level in five years. The 2013 surge took place after the S&P 500 rose above its 2000/2007 peaks to signal the start of a new uptrend. The new uptrend in stocks is bad news for gold.
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Chart 8
GOLD UNDERPERFORMS COPPER AS STOCK MARKET RISES... The gold line in Chart 7 is a ratio of gold divided by the price of copper. The gray area plots the direction of the S&P 500. Notice the tendency for the two lines to trend inversely. The ratio rose during the SPX downtrends during 2001 and 2002, and again during the stock collapse of 2008 (as investors bought gold). The gold/copper ratio fell during the stock market uptrend between 2003 and 2007 and since 2011 (as they bought copper). Here's why. Gold is bought in times of financial stress when stocks are in trouble. Copper is bought when economic conditions are better and stock prices are rising. The gold/copper ratio tells whether investors are optimistic or pessimistic. The fact that the ratio has been falling over the last two years suggests more optimism on the economy and stock market. A stronger global economy supports the price of copper, and diminishes the appeal of gold.
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Chart 9
CRB INDEX OUTPACES GOLD AS RATES RISE... Chart 8 plots a ratio of the CRB Index divided by gold (brown line). During the last decade of economic stress, gold was the top commodity performer (producing a falling ratio). The CRB/gold ratio, however, has been rising since mid-2012. During that time, gold has gone from the world's strongest commodity to one of its weakest. That's why I suggested in a recent message that economically-sensitive commodities would benefit most from a weaker dollar and a stronger global economy (especially China), but not necessarily gold. The green area shows the rising trend of the 10-Year T-Note Yield (TNX) coinciding with a rising CRB/gold ratio. That also makes sense. Rising commodity prices suggest global economic growth and the early stages of inflation. That's the exact environmemt that has historically produced higher bond yields. Unfortunately, rising bond yields aren't good for gold. None of this is meant to suggest that gold can't enjoy periodic rallies. It does suggest, however, that gold is unlikely to regain its role as either a commodity or a currency leader.
