GOLDEN CORRELATIONS AND DON’T FORGET FALLING GOLD PRODUCTION

GOLDEN CORRELATIONS

The inverse relationship between gold and the U.S. dollar has implied a generally positive relationship between gold and currencies whose corre-lation with the dollar has the highest negative correlation. The euro has proven to be the most negatively correlated currency against the U.S. dol-lar due to the fact that EUR/USD is the largest traded currency pair in the foreign exchange market. And because the Eurozone is the world’s second largest economy after the United States, its currency is most apt to act as the anti-dollar, rallying at the expense of the greenback and selling off to its benefit.

Figure 1.10 illustrates the six-month gold correlations with the dol-lar index, the aussie, the euro, the yen, and New Zealand dollar from January 2002 to May 2008. The USDX is the only currency with negative territory, illustrating an average rolling six-month correlation of −0.53. Both EUR and AUD show the highest average positive correlation at 0.53 each, with the former acting as the anti-dollar and the latter correlat-ing with its vast mining industry. The JPY had the lowest positive aver-age correlation at 0.39. Notably, NZD’s six-month correlation with gold stood at 0.78 over the last four months of the measured period. Nonethe-less, the average of the NZD’s six-month rolling correlation from January 2002 to June 2008 stood at a mere 0.43. Any close correlation between the NZD and gold is attributed to the nation’s dependence on dairy prod-ucts as well as lamb and mutton, which have shown considerable prox-imity to the trend in gold. But the correlation between the agriculture-dependent currency and gold proves insufficient to last through most of the seven-year period.

AUD, EUR, JPY, NZD Correlations with Gold

FIGURE 1.10 Gold’s correlations are highest with Aussie and Euro.

DON’T FORGET FALLING GOLD PRODUCTION

So far, much has been discussed about the financial market underpin-nings of the rally in gold: falling dollar, falling interest rates, rising inflation, and investors seeking the safety of the metal during equity mar-ket sell-offs. But, as is explored in more detail in Chapter 8, the gold rally has been founded considerably on major supply and demand con-ditions. These included plummeting world production, rising commercial demand by wealthier working class populations, and soaring demand for commodity-based funds.

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Simply mentioning falling production as a reason is not enough for addressing factors behind the bull market in gold. Falling production has resulted from several factors, including chronic underinvestment in the mining sector; widespread power shortages in China and South Africa; pro-longed strikes and mounting contract negotiations by mine workers de-manding higher share of profits from surging metals prices; lack of skilled labor force as well as aging population of workers; and environmental re-strictions adding to existing delays. World gold production fell more than 1 percent to 2,444 tons in 2007, reaching its lowest level since 2004. After pro-ducing as much as 1,000 tons of gold in 1970 and assuming the world’s num-ber one spot in gold production, South Africa has seen its mining produc-tion decline for five straight years into 2007. In 2007 alone, South African production fell 8 percent to 272 tons of gold, dropping to second place for the first time since 1905, according to GFMS.

Falling global oil production was somewhat stabilized by China’s ris-ing production, where output rose 12 percent to 276 tons of gold in 2007, accounting for 10 percent of total world production. China went from producing 71 tons in 1988 to 134 tons in 1998 and to 276 tons in 2007. (See Figure 1.11.)

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