Why Isn’t Gold Pulling Up?

Gold and major precious metals companies haven’t performed well in recent weeks. The decision the FOMC to launch another quantitative easing didn’t seem to help, for now, pulling up the price of gold. Let’s examine the recent developments related to the gold market, try and breakdown what might have held back gold from rising, and 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&P500 index has also edged down by nearly 4.6%. Gold related companies such as Royal Gold, Inc. (NASDAQ: RGLD) also didn’t perform well during recent months and fell by nearly 14.5%. Barrick Gold Corporation (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 S&P500 in the past three months.

gold and snp500 and royal gold

As seen above, all of the above 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 the price movement of the Royal Gold’s. 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 USD 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 the U.S GDP growth isn’t high but at least 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 decline in the price of gold as it lowered the uncertainty around the US economy.  Alas, the upcoming budget talks that will continue to occupy the U.S news cycle may raise again the uncertainty. The highly talked “fiscal cliff” could affect the direction of gold. 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 program 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.

gold and money base

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.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.