INTERMARKET ANALYSIS
Of Gold And Bonds, Gold Is The Leader
by Alex Saitta
Does gold lead the bond market, or is it the other way around?
Previously, we uncovered strong coincidental relationships
between gold and the dollar, inflation, bonds and the CRB index. As bond
traders, though, we are most interested in the relationship between gold
and the bond market. Looking at the past 20 years of data (Figure 1), we
noticed gold's reversals have led bond yield reversals. Looking beyond
the peaks and valleys and considering all the data, does gold have a tendency
to lead the bond market?
FIGURE 1: GOLD VS. YIELDS. In a quick look at the past
20 years of data, gold's reversals appear to have led bond yield reversals.
To answer this question, we applied basic statistical analysis to measure
relationships between two series of data. Correlation analysis measures
the degree of association between all the data points of two series. The
product of this mathematical comparison is referred to as the correlation
coefficient. Correlation coefficients range from -1.0 to +1.0 and identify
the direction as well as the strength of a relationship between the two
series being compared.
For example, a coefficient of +1.0 represents a perfect positive relationship.
When one variable rises, the other rises in lockstep. When one falls, the
other falls in lockstep. A coefficient between zero and less than +1.0
is a nonperfect positive relationship. When one variable rises, the other
usually rises somewhat. When one falls, the other usually falls somewhat.
A coefficient of zero, however, indicates no relationship. A coefficient
of -1.0 is a perfect negative relationship. When one variable rises, the
other falls in lockstep. When one falls, the other rises in lockstep. A
coefficient greater -1.0 and less than zero is a nonperfect negative relationship.
When one variable rises, the other usually falls somewhat. When one falls,
the other usually rises somewhat.
WHAT IF?
If gold is a leader, its correlation with the bond yield will be greatest
when gold is lagged a certain number of periods. A simple example can be
seen in Figure 2. Series A leads series B by five periods, so whatever
occurs in series A in a period will be reflected in series B five periods
later. For example, series A fell from periods 1 through 9 and then made
a low. Series B, lagging five periods, fell periods 6 through 14 and then
made a low. In period 13, series A put in a short-term high, and five periods
later -- period 18 -- series B made a high. If a correlation analysis is
performed on these two series and series A is lagged five periods, the
correlation would be a perfect +1.0.
