What Is The Gold Price Telling Us About The Stock Market?

• Stocks are rising against gold and that’s bullish
• The long-term trend points to gold under-performing stocks
• Stock/Gold ratio breaks out from a right-angled broadening formation

The price of gold, over the short-term, typically rises and falls on global tensions or lack thereof. Longer-term trends though, are more influenced by the expectations of market participants on future inflationary trends. Since gold offers no return, apart from capital appreciation, its price is also influenced by the trend of real interest rates. So what does that have to do with the stock market? Nothing really, except that the relationship between stocks, which thrive on stability and gold, which does better when the outlook is especially uncertain, provides some really great signals for future stock trends. Right now, that relationship is very bullish for stocks.

Stocks are rising against gold and that’s bullish

Chart 1 compares the ratio of stocks/gold to the performance of the S&P Composite itself between the early 1990’s and 2018.  When it is rising, that tends to be positive for equities. When it’s falling, stocks are at their most vulnerable, but do not necessarily decline. Examples developed  in 2005, and between late 2008 and late 2012. They have been flagged by the two dashed blue arrows at “1” and “2”. In both instances, the ratio declined but stocks experienced a net advance. One way of identifying whether the ratio is in a rising or falling trend is to compare it to its 12-month MA. When it’s above the average the trend is considered positive and vice versa. Using the benefit of hindsight, the green shaded areas tell us when the ratio experienced an extended period above its MA. It’s true that there are many instances of whipsaws. The more egregious have been flagged with ellipses. However, the exercise at this point is not to use the 12-month MA relationship as a precise timing device, but more to demonstrate the point that when stocks are out-performing gold, it offers better than average returns on stocks. The chart further shows that the ratio crossed above its MA in late 2016 and has remained there ever since.

Chart 1

The long-term trend points to gold under-performing stocks

Having established that a rising stock/gold ratio is bullish for equities, how can we determine when the environment for stocks might be changing from bearish to bullish? Chart 2 demonstrates a very simplistic approach using trend lines. It’s not always possible to construct them of course. When it is, and their violation is confirmed by an equivalent trend line break for the S&P itself, we are presented with some pretty reliable signals. One thing that is fairly obvious from the current situation, is that the ratio broke out from a 12-year base in mid-2017. It subsequently pulled back towards its top, but remained above its 12-month MA. This week the ratio has re-affirmed the breakout by registering a new recovery high. Bear in mind though, that this is a monthly chart and we are only half way through the month of June. The latest plot is therefore an “estimate”.

That said, the minimum ultimate upside objective from the mid-2017 breakout is consistent with a substantially higher ratio. You can appreciate that from the fact that the solid blue arrow to the left of the breakout, which measures the depth of the pattern, indicates substantially higher prices when projected from the breakout point (second blue arrow). Of course this is a guide, and the objective may never be achieved, though the indication to reach the area of the 2000 all-time-high does give it credibility. Even if the ratio just rallies to the half-way point, that should provide great support for the stock market.

On the other hand, we should always look over our shoulder and ask ourselves the question: What is the technical event that could cancel such a positive outlook? As far as the ratio is concerned, that would be a decisive month-end close below the dashed up trend line and 12-month MA. Remember, you can update this chart simply by clicking on it.

Chart 2

Stock/Gold ratio breaks out from a right-angled broadening formation

Things are also looking up for the stock/gold relationship near-term. That’s because it is currently breaking out from a right-angled broadening formation. These price patterns are really the opposite of right angled triangles. In this instance though, the two trend lines marking the extremity of the pattern diverge instead of converging. A triangle reflects a battle between buyers and sellers that is gradually becoming more finely balanced and under control. By way of contrast, the broadening formation with the flat top, as it is alternatively known, experiences greater and greater instability, fraught with whipsaw signals as prices register progressively lower lows. Because of this growing volatility and false declines, upside breakouts in this type of formation are usually followed by above average moves. This probably happens because sellers are completely exhausted by the time the price finally breaks to the upside.

One small caveat, and that lies with the fact that this is a weekly chart based on Friday closes. That’s why this Friday’s close could be an important one in the event that the ratio closes below its current 2.15 reading. This seems unlikely because all three KSTs are currently in a rising, but not super-bullish mode. This also supports the idea of a stronger ratio.

Chart 3

Does that guarantee that stocks are certain to move higher? No, of course not, because there are no guarantees in this business, except perhaps that greed is guaranteed to lose you money! A rising ratio though, does put the odds of higher stock prices at a pretty elevated level.

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.