Many strategists believe the US dollar is in the beginning stages of a possible multi-year bull market. If true, and the historical inverse relationship between gold and the dollar remains, this would imply a similar long-term negative outlook for gold.
A reader recently asked about the changing historical correlation between gold and the dollar and the implications this has for gold going forward should the dollar continue to rally. This was a topic Charles Hugh Smith and I briefly touched upon in Tuesday's interview, with Charles also raising the possibility that we might see the traditional inverse relationship break down should the market see a major sustained selloff and a flight to safety trade develop.
In order to provide some meaningful projections around this topic, we need to address at least two important questions: 1) How strong has the negative correlation between the dollar and gold been historically? and 2) Do we see this relationship indeed break down during times of panic? As I'll show below, the answers to these two questions are "strong" and "only briefly".
With regards to the first question, we provide the following chart showing the dollar and gold from 1980 to present with the changing strength of the correlation ranging between strongly positive (red region) to strongly negative (green region) shown beneath.
From the chart above we can see that when the dollar tends to rise, gold tends to fall and vice versa. The strength of this inverse relationship between the two is made even more apparent when we look at the amount of time that the correlation remains within the green (strongly negative) region over prolonged periods of time. On the flip side, the two have only seen a strong positive correlation for a sustained period (a year or more) on a few occasions over the past 34 years (red circled regions). Thus, the inverse relationship between the two is quite strong and persistent over long time frames. When the dollar is rising, the overall trend therefore for gold is negative.
Let’s now examine how gold and the dollar move during times of panic to try and answer the second question. I’ve now added a chart of the S&P 500 on top to see the relationship between the market, the dollar, and gold.
The 1987 Crash
In the 1987 crash, when stock markets around the world saw massive declines in a very short period of time, we see the dollar generally selling off while gold rose. After that event, the two saw a strong positive correlation several times (red circles) but, over the long run, quickly reverted back to their negatively correlated state.
2000 Top and Bear Market
During the 2000 top in the stock market and ensuing bear market, we see once again gold and the dollar remaining mostly negatively correlated except for a few brief periods where they inched slightly into strong positive correlation territory.
2007 Top and Bear Market
Following the 2007 top and ensuing bear market, we see the same pattern hold true again: gold and the dollar maintain a largely strong negative correlation over the long-term except for a few occasions.
Today
Looking at the present, we see a very persistent and strong negative correlation between gold and the dollar, with only a slight deviation from this trend in the recent 10% selloff in stocks. There was only one occasion back in October of 2013 when gold and the dollar moved into strong positive correlation territory, but that too only lasted for a brief period.
What Are the Implications?
A large number of strategists believe the dollar may be in the beginning stages of a long-term bull market lasting anywhere from 1-3 years due to the major divergences in monetary policy between the US, on the one hand, and Europe and Japan on the other. Furthermore, with the exception of the 1987 crash, in times of panic (as seen during the bear markets following the 2000 and 2007 top) the strong negative correlation seems to break down only temporarily, perhaps for a period of a few months, before realigning again. If these things continue to hold true in the future and the dollar indeed continues to rally for another 1-3 years, this would imply a negative outlook for gold going forward.
Related:
Russell Napier: Invest for a Deflationary Environment and a Strong Dollar
Marc Chandler: Be Prepared - Dollar May Climb for Several Years
John Kaiser: Strong Economic Growth – The Real Driver of Gold Prices
