What are the Market Correlations and how to keep track of them?
The concept I will talk about in this video is market correlations. It means that different market assets being correlated to one another. The video regards the question that I received trough social media which was ‘I noticed today that gold rose as a result of treasury yields dropping and I had no idea they were correlated had I known I could have gained a lot of pips from gold increasing today because I actually was already aware early that the yields were dropping but did not know it was correlated with gold’.
First all, in the general sense lots of different assets in markets are correlated and the easiest way to explain how and why is all to do with Risk-On Risk-Off. So the Risk-On is when the market gets kind of greedy and not scared of risks. You have probably heard the saying that the market cycles between fear and greed. In it’s greedy phase market will try to make as much money as possible . So the traders will be attracted to those things that give the high yield. For example, in currencies they will be attracted to those currencies that are paying the highest interest rate. Obviously with yield comes more risk. When market is scared (Risk-Off), traders do not care about yield anymore because they simply want to go for safety.
In this question we are specifically talking about gold and US bonds. What’s the correlation here? Bonds and gold are both Risk-Off assets. So if the markets get scared for example, whenever the stock market is crashing, you might notice the prices of gold and the value of bonds to go up. When the value of bonds go up the yield goes down. In exchange for safety of gold or bonds you do not really get a yield. That’s exactly what happened in the given question. I do not know exactly what date it was or what was the situation but even just by looking at what happened we can see that it was probably risk off day. Everyone was buying into gold because they did not want to take any risks. So the value of gold rose and at the same time the value of treasuries was going up. So obviously the yields on those treasures went down.
When you see the yields going down it is a very good indicator that as long as there is a good reason for this (this is when you need to look at the fundamentals) the value for the risk off assets such as gold will go up. In the currency markets a risk off asset is Japanese Yen. Therefore the value of Japanese yen goes up when the market is scarred. When the market is not scared and does not care about risk it will go for currencies that have a high yield. For example, at the moment when I’m recording this video in 2015 high yield currencies are New Zealand dollar and Australian dollar.
To sum up, it does not really matter which markets it is. It does not have to be gold, does not have to be bonds it is all about whether it is a Risk-On Risk-Off asset. So if you see treasury yields falling first thing you need to do is look for the reason. Is something happening in the market that caused a concern or panic? If that is the case, you got a very good chance of making some money by buying gold. If it has not started moving there is a pretty good chance it will start following.