There are a number of odd correlation divergences taking place in the gold market, many of which may redress themselves in the form of mean reversion if historical patterns play out. Looking at it from a fundamental perspective, a Macquarie report sees little shift in central bank demand and thus anticipates that any change in the supply and demand equilibrium will need to come from institutional investors. But if the correlation divergences are addressed in markets, it could lead to a tailwind for gold.
With a weaker than anticipated jobs number reported Friday – the US economy added 103,000 jobs were added in March, well shy of the 188,000 anticipated – gold shot up nearly $6.30 per ounce, trading near $1,333 per ounce.
After trending higher from a December low to a January high, the price of gold has been largely range-bound since. Even with Friday’s boost it still remains in the middle of its trading range amid certain correlation divergences.
The oil / gold ratio is pointing to a correlation range at the outer edge of its historical range, Bloomberg Intelligence pointed out. One ounce of gold currently buys 21 barrels of oil, significantly less than the two-year average of one ounce buying 25.4 barrels.
Another correlation breakdown is occurring in the ratio between gold and real interest rate yields. Top Down charts points out the 5-year real yield, the US 5-year Treasury yield minus the US 5-Year Inflation SWAP, has meaningfully inverted. Since the end of 2017 real yields have spiked while the price of gold has, likewise, risen. Typically, these assets have an inverse correlation.
Macquarie looks at the fundamental supply and demand, pointing to 2017 that saw physical demand fall by 4% and supply fall 3% on a year over year basis. They don’t see “price fireworks” occurring as a result, with only small changes occurring in their fundamental forecast for 2018. Rising gold prices in light of these factors portend well for the price of gold in the future, as does a potential reversion to the mean on many of the correlation ratios, if this should occur.
Macquarie is only “mildly positive” on the price of gold. In order to see meaningful price increases, institutional investors will need to be a force in demand growth. On the supply end of the market, mining production could fall over the longer term, both of which could help boost prices.
