By Sumit Roy, Fri Nov 12 02:36:00 GMT 2010 
Gold has been receiving an increasing amount of attention recently as the metal soars to new record levels. But you don’t have to trade gold to benefit from the metal’s recent volatility. In fact, many of the popular currency pairs have been moving in tandem with gold, offering forex traders an opportunity to piggyback on the uptrend or bet against it, with the added benefit of trading within the world’s deepest and most liquid market.
The following table includes the correlation between gold and the most popular currency pairs over various timeframes. A value close to +1 indicates a strong positive relationship between gold and the pair, while a value close to -1 indicates a strong negative relationship. --------------------------------------------------------------------------------------------------------------------------------- Weekly Commentary: We saw some interesting developments in Gold – Forex correlation this past week. On the surface it looks like there was a significant breakdown in the strong inverse correlation between gold and the U.S. Dollar. In fact, we saw the dollar index rise in every one of the last five sessions, while gold rose in four of the last five sessions. But if we take a closer look at the numbers, we see that the breakdown really occurred between EUR/USD and gold. Because the Euro makes up such a substantial portion of the dollar index at 58%, fluctuations in the index are dominated by movements in the EUR/USD exchange rate. The daily correlation between gold and EUR/USD over the past month plunged from 0.73 last week to -0.17, indicating that there was largely no statistical relationship between the two in the latest week. On the other hand, the correlation between gold and every other major pair with the exception of USD/CHF, strengthened. This is quite remarkable and underscores that traders are buying gold not necessarily as a hedge against a falling U.S. Dollar, but a hedge against the debauchment of fiat, or “paper,” currencies in general. The United States and the Eurozone economies are two of the biggest culprits in this regard, having established extremely loose monetary conditions, even going so far as to purchase government debt on a large scale (aka quantitative easing). The Japanese economy is yet another with an extremely loose monetary policy, but conditions there are somewhat different given that deflation has been well-established for some time now. It is not surprising to see the commodity currencies maintaining their strong correlations with gold. Much stronger economic conditions and rising interest rates have led to relatively tight monetary conditions in the likes of Australia, New Zealand, and Canada. But while the strengthening of gold’s correlation with USD/CAD, AUD/USD, and NZD/USD may have been expected, that is not the case with gold’s correlation with GBP/USD. Indeed, one could have reasonably anticipated that the Pound’s correlation would weaken in step with that of the Euro, but a surprising change of tone from the Bank of England in its Quarterly Inflation Report boosted the currency. Going forward, the fate of the commodity currencies and gold will remain closely related, both dependent on the outlook for monetary policy in the United States and the Eurozone. Were the Fed or ECB to signal interest rate hikes, both gold and commodity currencies would likely tumble. A strengthening of economic data in the U.S. and in Europe may be seen as a precursor to rate hikes. Finally, it is worth pointing out that while daily correlations between gold and most of the currency pairs slightly strengthened, intraday correlations completely fell apart across the board. Not a single pair displayed a meaningful 60-minute correlation with gold over the past week. We can attribute this breakdown to unusually volatile gold price action, and do not see it as a leading indication of a breakdown in daily correlations.
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Gold ETF holdings rose for the first time in four weeks, but just barely. Prices continued their ascent, surpassing $1400 for the first time ever as momentum established after last week’s Fed policy meeting continued to boost prices. In the short-term, it looks as if the correlation between gold ETF holdings and gold prices has completely broken down, but we would remind readers that over the longer-term, there is an extremely strong relationship between holdings and prices; caution is thus warranted.
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Fri Nov 12 02:36:00 GMT 2010
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Gold ETF holdings fell for the fourth time in five weeks, while gold tumbled almost $95 peak-to-trough from last week’s record level of $1424.60. Although prices have rebounded from the recent lows under $1330, we can’t help but wonder if the advance is getting long in the tooth. ETF holdings are near levels they were at back in July, but gold prices are $100 higher than they were at that time. Over the last several years we have observed an extremely strong relationship between these two variables, thus caution is warranted. Nevertheless, there is always the possibility that demand is coming from other segments of the gold market such as the physical investment side, which we cannot measure in real-time. 