4/4-4/8/16 Charts of the Week

While there were certainly some bright spots in the financial markets last week, equity indexes performed sub-par (pardon my Master’s golf related puns). The Dow Jones and S&P 500 both lost 1.4% on the week and have returned very little year-to-date…weekly dow

weekly sp500

Data was also released on international trade, the US Trade balance, and oil/natural gas inventories. Exports have continued to decline while imports have risen over the last 2 quarters, and February’s trade deficit was larger than expected, at -$47.1 billion. While natural gas inventories dropped, crude inventories have continued their growth trend…

international trade 2

 

international trade

 

oil inventories

This week we wanted to take some time to discuss interest rates and the impact they may have on commodities. As investors will note, commodities have performed very well year-to-date (disclosure: we have had significant positions in the precious metals mining sector for quite some time). Analysts are in the process of developing their thesis on why the Federal Reserve should or should not raise rates and what it does or does not mean for financial markets. We try not to get caught up in the bluster of analysts, and rather go straight to the market to see what investors are thinking, using the CME FedWatch tool…

rate hike odds

That circle in red indicates that based off of various trades in the interest rate markets, investors believe that there is a 1% chance of a rate hike taking place at the April meeting. Financial pundits have used price action in commodities markets to infer that low rates are good for commodities, when in reality it is the uncertainty regarding interest rate policy that has been driving commodities higher, along with concerns over the value of stocks and negative interest rate policies out of Europe and Asia.

This uncertainty has led the metals markets nearly 20% higher year-to-date, and both gold and silver posted solid returns last week…

weekly gold

weekly silver

One widely accepted fallacy is that low rates will without question result in higher commodity prices. This is entirely false. If investors will note the effective Fed Funds Rate from 2009-present (near 0%), this should have resulted in gold and silver soaring…

fed funds v gold

 

That was very clearly not the case, if readers will note the last dip in spot gold prices that took place from 2010-present…

Gold v Fed Funds

This period in time represented a positive correlation between interest rates and metals prices. Metals have and will always be more sentiment dependent than they will be data driven, which is why many investors find the metals sector so frustrating to invest in; it can be very tough to read.

Using statistical analysis, when we take the data from the Fed Funds historical rate chart and the spot gold price chart, using price and rate data from 1968-2016, we determine that a -.528 correlation exists between the Fed Funds rate and the spot price of gold. This correlation coefficient suggests that there is a mild inverse correlation between interest rates and gold prices, meaning that a mild relationship can be drawn concluding that if interest rates rise then gold prices will fall, and vice versa.

However, when we run the same analysis from January of 1980-January of 1990, that correlation coefficient comes out to .278, which indicates a mild positive correlation exists, or that during that period of time when rates rose, so did the price of gold.

The point is that while we use statistical analysis to make these determinations, they are by no means constant, and investors that apply their findings in a universal and absolute manner, without taking macroeconomic concerns into account, they are likely to misread the market and make poor investment decisions and timing errors.

As always, we encourage readers that are interested in our services and market analysis to schedule a consultation with us, it is free and we are happy to meet in person or communicate via email.

Happy trading!

Ben Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and licensed with FINRA (www.Finra.org) through Treece Financial Services Corp. The above information is the opinion of Ben Treece and should not be construed as investment advice or used without outside verification.
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