The price of gold has retreated by a sharp 3 per cent over the past week, while the S&P 500 index has risen nearly 1 per cent.
Big deal? Perhaps it means nothing that these two asset classes have begun to move in opposite directions after being closely correlated since the start of the financial crisis. But Mark Hulbert, founder of Hulbert Financial Digest and a columnist at MarketWatch, has written an interesting piece showing why the departure could be noteworthy if it continues.
"To appreciate what's happening, we need to recall that the relationship between gold and stocks this week is actually the historical norm," he wrote.
That is, gold and stocks used to move in opposite directions throughout most of the past few decades, which is why some observers recommended that investors use gold as a diversification tool. But with the financial crisis, the two assets began to move together, which was unusual.
Why gold and stocks would move together is a bit of a mystery. Mr. Hulbert's explanation is that they move in different directions during times when inflation is expected, but move together when there is a fear of deflation. This isn't a very satisfying explanation, however.
Mr. Hulbert notes: "When the dominant worry shifts to the possibility of deflation ... then both gold and stocks will tend to become quite highly correlated. That's because gold will go down in price during a deflation, just as stocks will also suffer because of the prospect of an economic collapse that a deflation makes more likely."
But this doesn't seem to be the case. Gold appears to be feeding off the threat of deflation, with the price rising more than 80 per cent over the past two years. Stock prices have also been improving since March, 2009, suggesting investors here, too, aren't worried about the threat.
Still, the recent departure of the two assets is interesting and well worth following in the weeks to come.
David Berman