Wednesday, June 15, 2005

Dollar and gold decoupling?

Are the dollar and gold decoupling? Lately the very tight negative correlation between gold and the dollar has vanished. Over the past couple of weeks as the dollar has rallied, so has gold. Theories:

1) Short-term aberration

2) Euro money that’s still afraid of the dollar—It could be that those disappointed in the euro, still have little faith in the dollar as a store of value—so where else to turn—gold. And as the gold price rises sharply in local currency terms (outside the dollar) the rising price trend creates an incentive to add to positions.

3) Financial risk building in the system—attached below is the same series as above, but this time it is on a weekly basis – US $ Index (inverted) verse gold futures. What’s interesting is that the last significant “decoupling” we saw coincided with the Asian Financial Crisis and was exacerbated by the blow up of Long Term Capital Management (LTCM), September ’98; the Trading Wizard hedge fund of the day. The demise of LTCM was a real blow to the global financial system through its labyrinth of intricately linked derivative relationships. The Fed and assorted big boys had to step in and fill the breach.

What was interesting during this same time was the action of the bond market—it was in the midst of a blow-off rally, maybe driven by a safe haven run into Treasury bonds.

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