What, if anything, does the current high correlation between the two variables tell us.

Recently, as the cover chart demonstrates, the relationship between the price of gold (in black; don’t ask: the colors were selected by the system) and the USD/Yen rate (in mustard yellow) has been very tight. The correlation in the graph is -0.73 and it basically says the value of the Yen and the price of gold have moved up/down very closely together in the last two months (remember: if USD/Yen goes down the Yen is strengthening because it takes less yen to buy a US dollar, and vice versa).

There are some possible reasons for this phenomenon, the most popular being that both the Yen and gold are considered “safe havens”: when they are increasing in value the general idea is that investors are looking for protection from economic or financial troubles (real or perceived).

As you know I have been feeling uncomfortable about the current state of affairs for some time, and so this potential signal for (big?) trouble down the road is reassuring in a sinister way. But the correlation of -0.73 is just too high to be left alone; I decided to go back in time and look at a sample of major market events to see what happened to the correlation during those periods.

First I looked at the last twelve months; as can be seen in Figure 1, the relationship broadly held but is was looser than recently with a correlation of -0.51:

Figure 1


Then I looked at other two-month periods around significant dates. Working my way backward from the most recent to the oldest, Figure 2 looks at the relationship during Lehman’s failure (USD/Yen is the black line and gold is the green one; correlation -0.44):

Figure 2


Figure 3 covers the two months around the stock market peak in 2007 (correlation was a positive +0.22; some people wanted safety, some didn’t):

Figure 3


Figure 4 is the Tech Bubble peak (-0.10):

Figure 4


Finally, Figure 5 is what happened to the relationship during the Crash of 1987 (USD/Yen black, gold mustard yellow; -0.26):

Figure 5


For the record, the long term correlation between USD/Yen and gold (last 46 years) is -0.21; for the last 10 years it has been -0.27 and for the last 5 -0.29. Also the relationship described does not change radically if you use a broader Yen index (like the Bank of England’s trade weighted index) in the calculations.

In essence, by a cursory look at the material above it would appear that more recently market participants have migrated towards both these trading alternatives in an unusually coordinated fashion. I can only speculate as to the reason behind such behavior. One thing that comes to mind is that perhaps a good portion of the financial stress in the world today is concentrated in the Far East, especially in China.

Or there’s always the possibility the current tightness of trading in USD/Yen and gold is just a plain spurious event, like hundreds of others out there.

Only time will tell.

-Photo Sources-
All pictures are from Bloomberg.