Thursday, April 2, 2009 0 comments ++[ CLICK TO COMMENT ]++

Quick look at YTD performance of gold, US$, and S&P 500

Gold has been weak of late and I wanted to take a look at what has happened so far this year. Gold is important because it should indicate if the market is rallying on the re-flation thesis. If money printing, or future inflation, is what is driving the asset prices then one would expect gold to move up as well*.

The following year-to-date price** chart plots the US$ index (fittingly in green), gold (a not so fittingly blue), and S&P 500 (tan):

So far, gold is largely flat for the year; so is the US$ index. Both are up only 5% (although 5% is a huge move for a currency during normal times) while S&P 500 is down around 10%. So gold hasn't really declined for the year.

If the stock market rallies without a big decline in US$ or a big rally in gold, I would consider that extremely bullish. Such a scenario likely portends to improving economic fundamentals. In contrast, if the stock market rallies because the US$ plunges, it may just be inflation. A lot of people don't realize that the rally in American stocks from 2003 to 2007 was largely an illusion of sorts. A lot of the gain was due to the decline in the US$. I, as well as most foreign investors, know this first hand because I had huge unrealized losses from the currency decline. In Canadian dollar terms, the S&P 500 never came anywhere near the 2000 peak, whereas it reached the 2000 peak in local currency (US$) terms. Admittedly the C$ was a super-commodity currency so it rallied a lot so other foreigners may not have seen as big of a difference. Nevertheless, the American stock market did not go up much from 2003 to 2007 if you adjust for the US$ decline.

One of the calls I made at the start of the year was how this year is going to be tough for the bears and the bulls. Last year, the bears cleaned the series but this year is going to be tough for both. So far the game is playing out as I had anticipated. If you were a short term trader--I am not one--I'm not sure what you would do here.

* But do note that many factors influence gold, including central bank gold sales, sentiment, euphoria, mining supply, and so on, so you need to consider other possibilities as well. If gold drops 20% tomorrow because of a massive central bank gold sale, that doesn't imply that the decline is pointing to massive deflation.

** One should try to look at total return charts but I don't think dividends matter here since they are so small in this time period. The difference between a price chart and a total return chart is really evident with long time frames. If you plot stock prices against gold over the last 50 years, there would be some difference; but if you plotted stocks including dividends, it isn't even a contest. A lot of the charts we see, particularly old charts covering the 1800's and early 1900's, are price charts which understate actual asset returns. For instance, the Dow Jones was largely flat for something like 40 years from 1880 to 1920. But if you included dividends, which incidentally were higher than bond yields quite often, stock investors actually did well.


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