We invite you to visit our new blog at The Firecracker Report.

Gold Stocks Lagging Gold Prices - Traditional Correlations Breaking Down

Since September, some interesting dynamics have been unfolding in the gold market. While
physical gold prices have soared to new highs, gold stocks have not followed through.

$1097

$1062 $1061

$1058
$1032
$1016
$1014
$989 $1004
$961
$952
$933 GG Peak stock
$931 price $42.91
$912

Figure 1: Goldcorp (Ticker: GG) stock price versus the price of Gold/oz (blue
arrows).

The Chart above maps out the stock price of Goldcorp (GG) versus prices of physical gold.
As we can see, even though Gold made new highs in October and November, Goldcorp‟s
stock price did not breach its Sept high of 42.91. Now we have used Goldcorp here as an
example but the above dynamics are true for virtually all gold miner stocks.

In addition, an examination of monthly correlations between Goldcorp‟s stock and 3

variables: the S&P 500, underlying physical gold prices and EUR/USD exchange rate
respectively, throws up some interesting trends. (Note that these Goldcorp correlation
dynamics will extend to all mining stocks).

1 The Firecracker Report

As shown in Figure 2, in July 2009 Goldcorp stock moved in strong correlation with all 3
variables. However, off late (Oct-Nov) its correlation with underlying physical gold and the
USD exchange rates have broken down. Instead Goldcorp prices appear to be now highly
correlated with only 1 variable the S&P 500.

Monthly Correlations
GG Stock and S&P 500 GG Stock & Physical Gold GG Stock & EUR/USD FX Rate
Oct-Nov 2009 69% 35% -24%
Sept 2009 40% 66% -25%
Aug 2009 15% 87% -79%
July 2009 85% 95% -92%
June 2009 69% 80% -69%
May 2009 6% 95% -93%
Figure 2: Monthly correlations between Goldcorp stock and 3 variables: S&P 500,
physical gold and USDEUR exchange rate.

Interestingly in May 2009 the reverse held true, with Goldcorp stock exhibiting strong
correlation with the EUR/USD FX rate and physical gold prices and almost no correlation
with the S&P 500.

So how come Gold stocks have delinked from underlying gold prices and become
strongly correlated with the S&P?

There are a couple of explanations:

1. The gold miner stocks are in cautious territory. The stocks appear to be pausing,
unsure whether physical gold prices will hold their current levels of ~$1100. Once
current levels have been firmly established gold miner stocks will move up to follow
gold higher, if not then miner stocks will correct.
2. In addition, there is caution in the market regarding a potential dollar rally and a
subsequent correction in the S&P. Given that the Fed has ended its quantitative
easing (QE) in US Treasuries, this removes some support from equity markets in the
form of POMO induced equity purchases (dealers leveraging QE money to buy
stocks). Equity and commodity markets could therefore correct downwards and the
dollar could rally a little bit. And although miner stocks have currently decoupled
from the dollar, in the event of a dollar rally, their historical strong negative
correlation could once again reappear.
3. As highlighted recently by Professor Roubini, any event that causes an unwinding of
the dollar carry trade could result in a huge short covering rally in the US dollar and
subsequent correction in the equity and physical gold markets. Given that the Fed
needs to raise ~$2 trillion in new treasuries this fiscal year, this event is not out of
question (see conclusion below for further explanation).

2 The Firecracker Report

 4. In a Bloomberg article, John Roque, managing director in technical analysis at WJB in
New York offers another explanation. According to him, “Gold may outperform
mining stocks to a greater degree than it did in the past because the creation of
exchange-traded funds is allowing investors to wager directly on the metal‟s price
without needing to buy mining stocks”. (This explanation is somewhat applicable but
does not explain the full picture.)

Conclusion

Overall the caution in gold miner stocks is justified. Although we strongly believe that gold
will move much higher than the current $1100 level over the long term, however in the
short term the picture could play out differently. The Fed is currently caught between a rock
and a hard place. On one hand it has announced a pause in its buybacks of US Treasuries,
while on the other hand it needs to borrow ~$2 trillion more by issuing new treasuries to
fund the budget deficits for 2010. Given that foreign central banks are keen to diversify
away from the dollar (as evidenced by the recent purchase of gold by India), we worry
about the Fed being able to fulfill their borrowing needs and still keep interest rates low.
Therefore we would err on the side of exercising great caution while going long the stock
market. The Fed may be forced to “induce” a flight from risky assets such as stocks and
commodities, into “safe” assets like Treasuries in order to keep the long end of the interest
rate curve under control.

The next few months are critical, and investors would do well to proceed with great caution.

About the Firecracker Report

The Firecracker Report is a financial and geopolitical analysis blog started by a team of ex-
Wall Streeter‟s with extensive banking and investing experience. We strongly feel that in the
current era of corporatized propaganda driven news the „real‟ news often goes unreported.
We have therefore chosen to lend our voices and join the growing ranks of independent
bloggers that aim to bring insightful commentary and analysis to their readers.

We invite you to visit our blog and would love to hear your thoughts and comments. We can
be reached at firecracker.report@gmail.com

Global Disclaimer
The contents and data of The Firecracker Report are published solely for general information purposes only and do not constitute
financial recommendation or advice. The content of this report is not to be construed as a solicitation or an offer to buy or sell any
securities or related financial instruments in any jurisdiction. The author(s) of the Firecracker Report are not licensed investment
advisors. Thus, the Firecracker Report does not give investment advice and does not advocate the purchase or sale of any security
or investment by you or any other individual. It is understood that investment decisions carry risk and are the responsibility of
individuals and their professionally licensed investment advisors. Investors should exercise prudence in making their investment

3 The Firecracker Report

decisions. This report should not be regarded by recipients as a substitute for the exercise of their own judgment. The author(s) of
The Firecracker Report may or may not have a position in any company, commodity or asset referenced in the report. Any action
that you take as a result of information or analysis in this report is ultimately your responsibility. Consult your investment adviser
before making any investment decisions.

The Firecracker Report does not guarantee the accuracy, completeness, timeliness, suitability, or validity of any published
information and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising
from its display or use. All information is provided on an as-is basis.

4 The Firecracker Report