Wednesday, August 24, 2011
In my earlier post today, I noted the very strong negative correlation between the Vix index and the S&P 500. Here's an illustration of another very strong negative correlation (-0.92), between the price of gold (white) and the yield on 30-yr Treasuries (orange). Very low Treasury yields are symptomatic of a market that is terrified of the outlook for growth and the possibility of deflation. Very high gold prices are symptomatic of a market that is terrified of all sorts of things, and very weak growth accompanied by expansive monetary policy which could lead to high inflation is just one. The extreme volatility and relative weakness of equity prices is symptomatic of a market that is extremely worried about the outlook for growth.
When emotions run high and confidence is low, prices can reach levels which don't make much sense. Such is the case with the seemingly inexorable rise of gold prices (typically associated with rising inflation risk) and the seemingly relentless decline of long bond yields (typically associated with very low inflation or deflation). It should be easy to deduce that one or both of those markets was likely to be proved wrong. The big reversal we saw today, with gold prices falling 8.5% from yesterday's all-time high, and 30-yr Treasury yields rising 25 bps from yesterday's post-2008 low, is a perfect example of what happens when two trends which were inevitably and mutually unsustainable collide with even the slightest bit of reality: business investment continues to rise and inflation is by no means dead.
Posted by Scott Grannis at 12:43 PM