Last week’s correction in the commodity markets saw one class diverging – precious metals. Both gold and silver held their levels while the price of oil dropped 10% in less than a week.
Yesterday, the price of oil dropped some more, but without precious metals to follow. It is not the first time when different commodity classes diverge, and this is exactly the reason why traders should pay attention to this divergence.
Gold reached a new all-time high in 2020. In the summer months of last year, the dollar was in such a bearish trend that it lost ground against all other financial assets – gold, silver, oil, stocks, FX rivals, you name it.
Yet, after the move above $2,000, gold reached a top and started a bearish trend. The trend was so bearish that almost one year later, the price of gold had a hard time bouncing. In the meantime, the other commodity markets started to decline, and the question is – what if the price of gold leads all the other commodities?
In other words, is it possible for the commodity markets to lag the price action seen in gold?
Real Yields – The Wild Card for Financial Markets
One cannot talk about gold without considering silver as well. The two assets have a correlation close to 1 – the maximum possible for two financial assets. Put it simply, a correlation of 1 reflects two markets in a perfectly positive correlation.
Precious metals have long been viewed as a hedge against inflation. According to recent data, inflation is just around the corner – all major central banks made no secret that inflation will rise in the months ahead.
If we use the simple analogy with the recent bounce in the price of gold, we should not exclude gold leading other markets. After all, rising real yields trigger a selloff in growth factors, as the chart below shows – earnings and sales decline with the rise in real yields.
5y5y Forward Real Rate Leads the S&P500 Forward P/E
A study by Nordea, a European investment bank, shows that the 5y5y (i.e., five year rate five years from now) forward real rate leads the SP500 forward Price/Earnings (P/E) ratio by three months. It is hard to argue with such charts, but it does not mean that the correlation will keep on giving.
However, it did hold for the last six years or so, so we can presume that the same might happen. If that is the case, a move higher in the price of gold should not be discounted by investors as gold might lead other financial assets by a similar period.