When Gold has moved more like a commodity different from the currency in recent weeks, the correlation indicates that the relationship with the currency, the dollar in particular: The euro is tightening.

While gold is clearly a monetary asset and will, if anything, extend its influence as the only non-fiat currency (especially following developments in Europe last week), it is clear that in recent weeks it has been moving more closely in line with the rest of the commodities sector than with currencies or other financial instruments. Correlation analysis however shows that the relationship with the $:€ rate is tightening, while that with the G6-trade-weighted rate appears to be relatively static. The price in euros, meanwhile, has been tightening its relationship with credit default instruments as concerns over European debt have intensified once more.

Obviously risk appetite is an important driver of short term movements in the financial sector and this has been a key to the comparative homogeneity of the commodities sector, stretching back at least as far as the collapse of Lehman Brothers. The correlation table shown here does demonstrate, however, that "perception of risk" per se, as measured in this case by the VIX volatility index, is taking something of a back seat to currency movements, while gold and the equities are forging ever closer links - and there has been a sharp strengthening in the relationship with the ten-year bond. All of this tends to confirm the perception that investors remain nervous and this argues for further highs in due course. The path will not be a straight one, however, as there are still possibilities of the occasional bout of liquidation as a result of distress and in order to raise funds. Any dollar strength is likely also to see gold falter.

Daily log-correlation of gold and other key asset classes

May Since Mar 7 post-Lehman
Silver 64.5% 65.9% 57.4%
WTI 60.8% 54.6% 24.6%
Palladium 58.1% 62.2% 45.7%
Copper 52.1% 50.3% 31.4%
Platinum 49.5% 64.0% 53.2%
S+P 30.5% 19.0% 3.0%
-36.5% -33.6% -21.2%
G6 -34.5% -34.5% -25.5%
REIT 15.8% 18.2% 3.6%
VIX -15.2% -24.8% -5.3%
Ten-year bond 14.9% 1.2% -3.9%
The $:€ rate has been one of the more important drivers of the dollar gold price during May at almost 37%, higher than the 34% correlation that has prevailed since the 7th of March when Greek debt was downgraded, and rather stronger than the 21% correlation since the day that Lehman Brothers filed for bankruptcy. The euro price itself, however, has scaled new heights in response to the further downgrading of Greek debt in the last week of May, not to mention prior downgrades elsewhere in Europe, and persistent disagreements within the Federal Open Market Committee about the outlook for the US economy and how to manage policy after the end of QE2.

Sentiment would also have been boosted by more political debate following the progress in the European Parliament towards allowing clearing houses to use gold as collateral. The proposal has cleared one hurdle, with the Committee on Economic and Monetary Affairs voting to allow central counterparties to accept gold as collateral under the European Market Infrastructure Regulation. This now needs to go to vote in the European Parliament and the Council of the European Union in July. While unlikely to have any specific impact on the overall supply-demand dynamic, the approval of the use of gold as collateral would further cement the metal's role as a non-fiat currency.

The close correlation with other commodity prices demonstrates mass movement of funds rather than the increased influence of any one individual element. Although the fall in silver was largely regarded as responsible for the rout in the commodities sector in the first half of May, the gold-silver relationship has always been a tight one. Gold drives longer-term trends on the back of financial and economic considerations, while shorter term moves in silver will often presage changes in trends among the two because of its higher volatility that often causes it to be used as a geared method of playing the gold price.

For the time being the commodities are moving together although platinum and palladium are taking a slightly different course on the back of positive investor sentiment with respect to their fundamental outlook. For the time being, though, underlying shifts suggest that when it comes to gold it should also pay to watch the currencies, closely. It is arguable that gold had become overbought in euro terms and that a further correction is now likely. Finally, one of the keys to the $:€ rate is of course the state of sentiment over European debt woes and that, by definition, impinges on the gold price. The correlation between the euro-denominated gold price and the Greek CDS ten-year credit default swap has been an impressive 24% since the date of the March downgrade of Greek debt, compared with just 2% since the date of the Lehman Brothers' collapse Gold's influences are always many and varied; Europe is currently an important key.


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