Intermarket Analysis: Gold, US Dollar, Crude Oil, and SP500

Above is a graph that illustrates how the stock market has changed relative to other markets such as the US dollar, Crude Oil, and Gold. The graph shows how prices have changed relative to June 1996. The method for computing these relative percent changes is as follows. In the graph above, the closing price on 6/3/96 was used a base and all subsequent closing prices were divided by the 6/3/96 prices. Doing this now compares the change from each of the investments and is expressed as a ratio relative to a specific price. This is a valid use of ratios.

As you can see, this shows a totally different view of the investments. As for the gold stocks and the XAU, they still haven't return back to 0, or their original prices set back in 1996 while the SP500 is still above its 1996 prices. What's more remarkable is that gold stocks couldn't rise above their 1996 prices amidst all of the global chaos, financial malfeasance, increased money supply that occurred since then. As an investor this is disturbing since one would need to ask if the Russian crisis of 1998 didn't make investors run for cover; and if the World Trading Center collapse didn't scare investors; and if the demise of Enron, MCI Worldcom, Tyco, Arthur Anderson, Sunbeam, and other conglomerates didn't scare investors into gold, then what will?

Stock investors from 1996 are theoretically still in profits (don't ask investors of Enron, MCI Worldcom, Tyco, Sun Microsystems, and many other technology shareholders) while gold investors are still losing. If you look at the chart from left to right, you can see that as the SP500 rose, gold stocks declined. The gold stocks even declined at the 2000 market top. If you look carefully, you'll see that the gold stocks declined from June 2000 to Dec. 2000. It was during this time that both the SP500 and gold moved together, when in the past they moved in opposite directions. After that, the XAU started to slowly make its ascent. However despite this meager ascent, the SP500's decline dwarf's the magnitude of the rise in the gold stocks.

Who jumped ship?

This graph also helps us to see if investors "jumped ship". The question asked was "did investors move their money from the broad market to the gold sector and would this affect prices"? Well, as you can see, investors only started to invest in the gold sector when the market broke the lows back in June 2002. In addition, you can see that gold stock prices spiked as the SP500 dropped. And if you look back in time, you'll see several spikes in the gold stocks whenever the SP500 drops. You can plainly see that there are investors out there that shift their money from the broad market to the gold sector when prices drop. However, since the Spring of 2003, both the SP500 and gold stocks are rising commensurately. This underscores that something has changed.

Broken Axioms

Aside from the noted reflections on the gold market's recent price reactions to global events, this graph provides you with an elementary intermarket relative strength comparison that quickly shows you how these four market's price movement behaved. In fact, the US dollar is still stronger than it was back in 1996; stocks are still priced higher; crude oil is higher, but gold is lower. What's interesting to note is that while crude oil rose in price from March 1999 to September of 2000, the stock market also rose. Then crude oil and the stock market fell together until April 2001 when they disconnected and reacted independently. What's interesting to note is that high crude oil prices were blamed as the cause of the stock market decline because oil prices were such a burden on corporate America. The problem with view is that why didn't stock prices rally up in September 2000 when crude oil prices declined? This glaring disparity teaches us that there are no axioms in finance. As the old adage says, "rules are meant to be broken". Another interesting disparity occurred with the US dollar. Despite the Treasury's efforts to devalue the US dollar by increasing the money supply (the change in money supply isn't depicted on this chart, but huge increases in the money supply have been injected into the banking system. see links below), the US dollar is still stronger than it was back in 1996. It's been decreasing in value lately but it is still relatively stronger than it was. Lastly another disparity is with gold. Gold is finally responding to the US dollar's decrease in value by rising, but the correlation between these two markets is lower than is perceived. Since June 2003 the US dollar is rising in value and so is gold. So the the traditional view that gold prices and the US dollar's prices are inversely related needs to be disguarded.

Another problem for gold is who needs it. When gold technicians look at prices 30 years ago they see gold trading at $800/oz. But what they don't tell you is that the reason gold was down in price for 20+ years is that like any other business it became more effiicient. Thirty years ago, men mined gold from deep within the earth and the the process of extracting gold was quite different. Now, millions of tons of earth are piled high and gold is chemically leached out of the dirt. The process of extracting gold from dirt is much cheaper and there are more piles of dirt being chemically treated that ever. So the cost of production dropped dramatically from the previous methods and the premium given to mining companies was removed from that sector. Gold mining margins dropped precipitously and like any mature industry the easy money disappeared. What was once a great business because of the high margins was now like any other commoditized industry. This is an odd statement because gold is a commodity, but the business of gold wasn't. Once the processes were updated and the industry became more efficient, prices dropped.

So let's get back to the the original question who needs gold. The history of money tells us the gold was the only store of wealth, but today governments around the globe have in concert replaced gold with paper money. Now history tells us that paper money doesn't last, but what if governments are successful this time. The point is that they have made it clear that they have no use for gold. It's all about credit and paper assets not gold or is it?

The real store of wealth today in the new millenium is energy - "black gold". That's why our stock market and crude oil prices are the only two investment classes that have risen in value since 1996. Everything else is secondary. Crude oil is the currency that all countries are competing for as the USA is the largest energy consumer. So while gold was a haven for future value, owning crude oil is better. The only reason investors will flock to gold is when a major superpower goes belly up, and let's get real; that isn't going to happen. Those in power will make sure of it. Currencies and interest rates will rise and fall like the tides of the ocean, but total failure is not an option.

Links to Money Supply Data:

A provocative view of money supply. A foreigners perspective of the USA. April 2003, An Editorial on Money Supply

Federal Reserve Bank Data:

M3 Money Supply	Velocity of circulation M3
M2 Money Supply	Velocity of circulation M2
M1 Money Supply	Velocity of circulation M1
Money Zero Maturity Money Supply MZM

created 9/18/03, ©2003 The Small Investor's Software Co.