Gold/Stock Correlation

[moda0306]

Since after 2008, gold and stocks, in odd form, have been moving with much more correlation than in the past, or at least it would seem that way.  Even when broken down day-by-day.

I know part of this has to do with the fact that this is a completely fed-induced recovery, with all sorts of unprecedented actions to try to boost the economy now at the future's expense, but I can't help but notice it and tend to not like it as far as the implications for the PP.

I loved that gold didn't collapse with stocks in 2008 like other commodities, but I'm wondering if we were to see another 20%+ drop in stocks whether gold would be so forgiving this time.  I can't think of a better metal to include in the PP, but simply stating that I could see 50% of the portfolio seeing significant losses if stocks were to crash again.  The nice thing is, if this were to happen (hypothetical 20% average loss by gold & stocks), if we can rely on LTT's to give us a 10% boost (probably closer to 15% including interest) and cash to stay steady, then the portfolio would only see a -7.5% return for the portfolio.  Not catastrophic, just unfortunate.

I also think a significant recovery of the Euro could bring down gold prices and simultaneously make US bonds look less rosy at the current rates... who knows the effect on the stock market (probably pretty good and enough to keep the machine humming).  I'm not saying the Euro will recover... simply that if it did we could see a reversal of the simultanious help we've gotten from both bonds and gold over the last few years.

Any thoughts on this?  I know we talk about these "what ifs" in spades, but I think it helps to rehash a few of these things once in a while and bring a new perspective to the assets, their correlations, and any odd behaviors and what their causes may be.  All said, the PP still looks great to me... I'm just trying to brace myself for a -5% year so if it does happen I'm not jumping ship at the worst time.  Historically, going in after or during weak PP years has been very lucrative (the next year usually does quite well).

[Gumby]

Since after 2008, gold and stocks, in odd form, have been moving with much more correlation than in the past, or at least it would seem that way.  Even when broken down day-by-day.

I know part of this has to do with the fact that this is a completely fed-induced recovery, with all sorts of unprecedented actions to try to boost the economy now at the future's expense, but I can't help but notice it and tend to not like it as far as the implications for the PP.

I loved that gold didn't collapse with stocks in 2008 like other commodities, but I'm wondering if we were to see another 20%+ drop in stocks whether gold would be so forgiving this time.  I can't think of a better metal to include in the PP, but simply stating that I could see 50% of the portfolio seeing significant losses if stocks were to crash again.  The nice thing is, if this were to happen (hypothetical 20% average loss by gold & stocks), if we can rely on LTT's to give us a 10% boost (probably closer to 15% including interest) and cash to stay steady, then the portfolio would only see a -7.5% return for the portfolio.  Not catastrophic, just unfortunate.

I also think a significant recovery of the Euro could bring down gold prices and simultaneously make US bonds look less rosy at the current rates... who knows the effect on the stock market (probably pretty good and enough to keep the machine humming).  I'm not saying the Euro will recover... simply that if it did we could see a reversal of the simultanious help we've gotten from both bonds and gold over the last few years.

Any thoughts on this?  I know we talk about these "what ifs" in spades, but I think it helps to rehash a few of these things once in a while and bring a new perspective to the assets, their correlations, and any odd behaviors and what their causes may be.  All said, the PP still looks great to me... I'm just trying to brace myself for a -5% year so if it does happen I'm not jumping ship at the worst time.  Historically, going in after or during weak PP years has been very lucrative (the next year usually does quite well).

Harry Browne has often said that any government or institution, with limited resources, can only affect the market for a limited amount of time. (That's how he knew that the US would have to go off of the gold standard, eventually.) Looking for changes in historical correlations over a three year period isn't going to help you, or anybody, come to any meaningful conclusions. If you believe in the free market, eventually one of the assets will break away from any short term correlations you or anyone else might be observing.

[MediumTex]

The easiest way for world governments to suppress the price of gold, if that's what they really wanted to do, would be to simply dump their enormous holdings onto the market all at once.

Anyone want to speculate on the chances of them doing this?

Anyone want to speculate on why central banks are holding so much gold in a fiat currency world in the first place?

[moda0306]

I don't think we'll see mass sellings of gold by nations.  It serves the purpose of giving them clout, IMO... I'm not sure if it's part of what pundits refer to as the "fed's balance sheet,"

If you hold a stockpile of nuclear weapons, you don't necessarily have to use them to give your military more influence.

I wonder what the guy who signed away all that British gold about ten years back is thinking to this day.

I'd be curious to see a graph (Clive??... jk... kinda) of nations' monetary base to gold-holdings ratio, or to know the history of any fiat currencies that have failed or been weakened by their central banks not holding enough gold.  This is interesting to me because there's a conflicting nature between saying a gold standard doesn't work and having central banks hold so much of it.

[MediumTex]

There's a conflicting nature between saying a gold standard doesn't work and having central banks hold so much of it.

Bingo!

Remind the next person of this who says it is a barbarous relic.

[Gumby]

Also, keep in mind that QE is a source of inflation. So, for all practical purposes, we are seeing a QE-induced inflation on the value of stocks, in nominal terms. That doesn't necessarily mean that stocks are rising in real terms. We really don't know what's happening yet.

[moda0306]

I'd say that in the short-term, stocks are having very solid real gains... just because the money is what made the stocks recover doesn't mean that we can say we had 17% inflation last year.

Just sayin, though I agree that more than ever this "recovery" has been aided by quite unnatural forces.

I still have to wrap my head around the inflationary nature of QE... as the Modern Monetarists point out, the fed buying 0-3 year treasuries (yielding 0-1%) with cash in is almost like trading a cd for cash.  If the bank were to pay me $10k in cash for a $10k short-term cd, I don't necessarily think of that as having changed my financial position significantly.  I haven't digested the full implications of that, but it seems to me simply shortening the yield on existing bonds from 0-3 years to 1 minute (cash is kind of like an ultra-short-term bond) may not have the inflationary implications we think of when we hear "$600 billion of QE."

It's the lending of money by the fed to financial institutions at ultra-low rates, not buying of st bonds with cash, that perplexes me the most and seems to me to be the most unfair thing the fed does... at least on the surface based on my limited knowlege of federal reserve accounting.

[MediumTex]

QE wasn't inflationary in Japan.

It did not create inflation in retail prices or asset prices.

It may, however, have prevented more dramatic declines in prices and asset values.

One might say that keeping assets from falling in value is a form of inflation, but most people would not see it that way.

To my knowledge, QE has not worked in any convincing manner anywhere other than in economists' models.

[moda0306]

You are right MT.

I think the true inflationary (or anti-deflationary) "QE" that did the most was the buying of mortgages at face value.  Those were the things that were going to collapse in value, and the fed bought them at a song for the banks, as opposed to QE2, which seemed to me to be trading ultra-safe st bonds for ultrasafe cash.

It'd be like my house collapsing in value over a couple month period, and the fed coming in and saying "Well if we buy this house from you, along with millions of other houses, they'll hold their value, and since yours was valued at $220k last year on your property tax statement, that's what we'll pay you."  So in QEII, they probably paid market price for the bonds they bought, but in buying mortgages at face value in 2008 or 2009, they basically handed money right to holders of those bonds, hoping it would trickle down to main street.

That's what truly seemed to save (read: manipulate) the housing market and prevent the massive liquidation we may have needed. 

[Gumby]

QE wasn't inflationary in Japan.

It did not create inflation in retail prices or asset prices.

It may, however, have prevented more dramatic declines in prices and asset values.

One might say that keeping assets from falling in value is a form of inflation, but most people would not see it that way.

To my knowledge, QE has not worked in any convincing manner anywhere other than in economists' models.

I agree that QE may not be successful at stopping deflation, but QE does have some short term effects:

[MediumTex]

Gumby,

Great charts.  Thanks for posting.

Perhaps we should think of QE as sort of the fiscal equivalent of a cortisone shot.  It will make the patient feel better for a while.  When it begins to wear off, however, whatever problems the underlying condition was causing are likely to return.

(Meanwhile, the cortisone itself is setting in motion a new set of future health problems.)

[Gumby]

Perhaps we should think of QE as sort of the fiscal equivalent of a cortisone shot.  It will make the patient feel better for a while.  When it begins to wear off, however, whatever problems the underlying condition was causing are likely to return.

(Meanwhile, the cortisone itself is setting in motion a new set of future health problems.)

Exactly. And I think that article you sent awhile back from the Contrarian Investor also described it as a ventilator. Same idea.

[MediumTex]

Perhaps we should think of QE as sort of the fiscal equivalent of a cortisone shot.  It will make the patient feel better for a while.  When it begins to wear off, however, whatever problems the underlying condition was causing are likely to return.

(Meanwhile, the cortisone itself is setting in motion a new set of future health problems.)

Exactly. And I think that article you sent awhile back from the Contrarian Investor also described it as a ventilator. Same idea.

I like the image of Ben Bernanke with a big syringe of epinephrine sticking the economy in the chest repeatedly while Tim Geithner looks on like: "Dude, I sure hope this works".

[moda0306]

Ventilator's a perfect term, and I'd say most agree with that.

I think the real question is whether you're ventilating (and putting tons of resources int) a patient that is 120 years old and whose body is just giving up (due to misallocation of resources)... (think Austrian argument), or a 12 year-old kid, who is otherwise relatively healthy, and while the ventilator is keeping him alive, he just needs surgury to get back to full health health, but the doctors won't give that to him, they just keep him on the ventilator (thinking the Krugman-esque argument that we need a huge infrastructure jobs program and much more defecit spending to reprime the pump).

That's one question I haven't 100% answered for myself yet.

I find about 20% of Krugman's blog postings to be pretty intriguing... the other 80% are straw-man punching bags and partisan BS.  I would reccommend for people to check out his stuff once in a while though.  He is a mix of MT's deflationist theory (which flies in the face of what much of the conservative establishment is arguing today), with the obvious liberal big-government welfare-statism that makes a lot of us cringe.

[Gumby]

btw, I got those charts from The Draconian. It's a great blog with entertaining and informative commentary.

Clive posted a great article that was written by that author, awhile back, on how diversification is really a myth and gold is the only asset that doesn't really correlate to anything. That article is especially relevant to this topic of Gold and Stocks.

http://seekingalpha.com/article/262034- ... -diversify

Oddly enough, the author seems to be searching endlessly (on his blog) for a way to invest safely in uncertain times with low volatility, but seems oblivious to Harry Browne's Permanent Portfolio.

[MediumTex]

Oddly enough, the author seems to be searching endlessly (on his blog) for a way to invest safely in uncertain times with low volatility, but seems oblivious to Harry Browne's Permanent Portfolio.

Perhaps he will see it when he is ready.