Why Isn’t Gold Pulling Up?

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Gold and major precious metals companies haven’t performed well in recent weeks, and the decision by the FOMC to launch another quantitative easing didn’t seem to help. Let’s examine the recent developments related to the gold market, try and break down what might have held back gold from rising, and see what is next for gold.

Despite the launch of QE3 back in mid-September 2012, the price of gold hasn’t performed well. During recent months, from October to November (up to date), the price of gold has declined by nearly 2.7%. By extension, SPDR Gold Shares (NYSEMKT: GLD) also fell during the past several months by 2.8%. In comparison, the S&P 500 has also edged down by nearly 4.6%. Gold-related companies such as Royal Gold (NASDAQ: RGLD) also didn’t perform well during recent months and fell by nearly 14.5%. Barrick Gold (NYSE: ABX) tumbled down by 18.8% during the past couple of months.

The chart below presents the developments of the price of gold, Royal Gold, Barrick and the S&P 500 in the past three months.

<img src="/media/images/user_12845/gold-and-snp500-and-royal-gold_2_large.jpg" />

As seen above, all of the previously mentioned assets haven’t done well in recent months.

There is still a strong and positive correlation between the developments of major gold companies and the price of gold: during the year, the linear correlation between Royal Gold and gold reached 0.51. This means, under certain assumptions (linearity of relation, normality of data), the changes in the price of gold could explain nearly 26% of Royal Gold’s price movement. Moreover, during 2012 the linear correlation between Barrick and the price of gold was 0.65. These figures suggest that if gold won’t trade up in the near future, shares of major gold companies will continue to dwindle. 

Let's see what could have adversely affected the price of gold in recent months. 

The recent appreciation of the US Dollar against leading risk related currencies such as the Euro and Canadian dollar may have contributed to the weakness of the price of gold. During the past couple of months the Euro/USD declined by 1.2%. Moreover, during 2012 the linear correlation between the two reached 0.5. This figure could suggest, at face value, that nearly 25% of the price movement of gold could be attributed to the changes in the Euro/USD. This relation should be taken with a grain of salt: even though the relation is strong and robust, it does vary over time.

There were some positive reports regarding the progress of the U.S economy, the November non-farm payroll report was higher than anticipated, the manufacturing PMI continues to expand at a faster pace, and U.S GDP growth remains stable at 2% as of the third quarter of 2012.

The positive news about the slow growth in the U.S economy may have contributed to a decline in the price of gold as it lowered the uncertainty around the U.S economy.  Alas, the upcoming budget talks that continue to occupy the U.S news cycle may raise again the uncertainty. Thus, this could pull up the price of gold in the weeks to follow.  

Despite the launch of QE3 it didn’t seem to have much of an effect on the money market. The U.S money base only slightly increased during October. There are some who claim that the QE3 and future QE programs will have diminishing effect on the economy and monetary system compared to the first quantitative easing plan. The chart below shows the development of the U.S money base and the average monthly price of gold between the years 2007 and 2012.

<img src="/media/images/user_12845/gold-and-money-base_1_large.jpg" />

As seen above, the sharp rises in the U.S money base in recent years were most likely due to the first and second QE programs; the rise in the U.S money base coincided with the sharp rise in the price of gold. Moreover, the linear correlation between gold and money base (lagged by one period) was 0.312. This correlation suggests, at face value, that if the U.S money base will continue to rise, it could pull up gold prices. In such a case, in the months to follow if the QE3 will pull up the U.S money base, it could also positively affect the price of gold.

Therefore, despite the recent fall in the price of gold and by extension major gold companies, there is still a chance the price of gold will change direction and by the end of the year and early 2013 will resume its rally. In such a case this should pull up the stocks of major gold related companies.  

For further reading:

Gold and Silver Monthly Outlook for November

QE3 Is Here, So Why isn’t Gold Pulling Up?

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