The Rude Awakening
Baltimore, Maryland
Thursday, May 24, 2007 ------------------------- - Gold falls in line in a curious correlation,
- When fate shows up unannounced and what it means for your investment allocations,
- The peanut butter and jelly of the investment world and more…
------------------------- Eric Fry, reporting from a Marriott in Baltimore… Some things just seem to go together, like peanut butter and jelly…or Bogart and Bacall…or supermodels and bulimia. On the other hand, some things don't go together at all, like caviar and Coke…or CNBC and bearishness…or Jim Cramer and subtlety…or gold and the stock market. But fashions, tastes and historic tendencies sometimes change…at least for a little while. Coke and caviar is still a bad combination, of course. But what should we make of the newfound harmony between gold and the stock market? Historically, these two asset classes have charted distinctly opposing courses. But in the bizarre investment environment in which we now find ourselves, gold and the S&P 500 have become as flawlessly synchronized as Olympic Russian ice skaters. This odd occurrence might contain a grain of worthwhile \investment insight…or it might not. But let's take a peak… ------ Free Market Investor ------ Introducing: The World's Greatest Retirement Stock Double-digit returns and income checks… from a secret "pension-payout plan" that's otherwise off-limits to everyday Americans… Grab Your Share Here: Free Market Investor Special Report ----------------------------------- Chickens Don't Kiss
By Eric J. Fry Pigs don't fly. Chickens don't kiss. Gold doesn't track the S&P 500. That's just the way things are…or, at least, the way things WERE. Pigs still don't fly, of course, and chickens still don't kiss (at least not well), but gold DOES track the S&P 500…for the moment. What does this quirky development signify? And what does it portend? Or to combine these two questions into one very pointed question: Since gold has been following the stock market to the upside, wouldn't gold also follow the stock market to the downside? The answer to this question probably resides within the CAUSE of the curious correlation between gold and U.S. stocks. And that cause, broadly speaking, is "liquidity." What is liquidity? Simply defined, it is that vast pool of cash, credit and derivatives that animate financial asset prices. Increasingly, this vast pool is controlled by hedge fund managers, private equity firms and all the other professional investors who strive to justify their hefty fees. As these heavy hitters scour the globe to extract "alpha" (excess return) from the financial markets, they toss their "buy" orders at any asset class that offers a compelling potential return. All the world's major financial assets, therefore, are floating on the same vast sea of liquidity - U.S. stocks as well as Chinese stocks, Kansas farmland, Brazilian bonds and yes, even gold. Historically, gold and U.S. stocks have tended to diverge from one another. Whenever the S&P zigged in one direction, gold would zag in the other direction. This reliable non-correlation has emboldened cautious investors throughout the ages to allocate at least 10% of their portfolios to gold. Today, cautious investors continue to allocate a large portion of their wealth toward gold and gold stocks. But gold may no longer be the all-weather hedge that its admirers expect. Gold's behavior relative to stock prices has changed…a lot. "The observed tendency of gold to go up when stocks go down is no longer observable," remarks James Grant in the May 18 issue of Grant's Interest Rate Observer. "For a shining example of how things used to work, one need look no further than the events of October 18, 1987. On the day of the crash, the S&P fell by 20.5%, while the gold price rose by 3.4%." Even more recently, gold has maintained it reliably contrary performance relative to stocks. "From the opening months of the year 2000 until just recently," Grant relates, "gold and equities went their separate ways. While the Nasdaq fell by 45% and the S&P rose by just 11%, the gold price climbed by 133%." But something has changed. Gold has joined the "investment mainstream," says Grant. Gold and equities now dance arm in arm. 
As the nearby chart illustrates quite clearly (after a bit of explanation), gold's recent correlation with the S&P 500 is both quite pronounced and quite aberrational. A negative reading on this chart indicates an inverse correlation between gold and the S&P 500, whereas a positive reading indicates a positive correlation. So the greater the negative number, the greater the tendency of gold and the S&P to move in opposite directions. Conversely, the greater the positive number, the greater the tendency of gold and the S&P to move in tandem. Interpreting this chart, therefore, requires no expertise whatsoever. For the better part of two decades, gold exhibited an inverse correlation or non-correlation with the S&P. But over the last few months, the gold/S&P correlation has swung from consistently negative to sharply positive. Gold might as well be a member of the S&P 500. So now that this historically non-correlated asset has begun to track the S&P very closely, it has begun to fraternize with enemy, so to speak. As such, the next sharp downturn in the stock market might coincide with the next sharp downturn in the gold price…at least for a while. But sooner or later (probably sooner), gold's contrary tendencies will likely reassert themselves. A few months of uncharacteristic correlation with stocks does not automatically erase gold's legacy of non-correlation and wealth preservation. "The history of paper money is the history of debasement," Grant reminds us. "So we goldbugs accumulate gold, not so much as a hedge against the unknown but as an investment in the preordained. Paper money loses value. That is its fate." But fate rides the "local," dear investor, not the express. Fate almost always shows up where it should, but almost never shows up WHEN it should…or when an investor hopes it will. "It might be that this joining of hands of previously estranged classes of investment assets [has been] an aberration, and that a long-term, committed buyer of gold can safely ignore it," Grant concludes. "But I fear it's no fluke…If I'm right about this, gold may disappoint its many fans in the next bear stock market - that is, before the derangement of the world monetary system furnishes the fundamental cause for even higher prices in the years to come." --- International Energy Alert --- Revealed: The Rogues' Gallery of the world's top oil producers. And every one of them is getting ready for… "The Global Oil Grab of 2007" Alarming Predictions Signal a New Energy Crisis: Iran's army surrounds U.S. troops in Iraq…Russia's army invades a southern neighbor…Immigrants flood America's southern border in unprecedented numbers…Oil soars to $150 a barrel - and beyond. For the full report read this special report: Strategic Investments - The Global Oil Grab of 2007 | 
