Whenever you ask a market expert why gold has done so well, the reply always is “safe haven” demand. But does gold continue to enjoy ‘safe haven' status? Gold's traditional correlations with other asset classes have been breaking down in recent months. Since September 2011, gold has dropped 16 per cent even as the dollar has appreciated significantly. This contrasts with 2010 when gold and the dollar moved in tandem.

Apart from displaying a negative correlation with the dollar, gold has also begun to move in tandem with riskier assets such as commodities and equity in recent times. We examine gold's changed relationships with dollar, equity and commodities and also give the outlook on the metal.

Changing connections

The correlation (based on daily closing global prices) between gold and dollar has fallen from a high of 0.8 in January-June 2010 to a negative 0.6 in the last three months (correlation is a statistical measure that captures the extent to which two variables move together). The yellow metal has also displayed a rising correlation with commodities and equity in this period, reducing its value as a diversifier for investors.

Sample this: Gold's correlation with Reuters CRB Commodity index moved from negative 0.5 in the first half of 2010 to 0.8 now (from September highs the Reuters Commodity index has dropped 9 per cent and gold has fallen 16 per cent). The correlation between the stock market benchmark, MSCI World index, and gold which was negative 0.5 in the first half of 2010 is now at 0.3.

So, what has disturbed the correlation? Gold rallied 36 per cent in 2011 to touch a high of $1,921 in September, even as most asset classes tumbled. This could have prompted investors to book profits in the only asset where they made money — gold.

Outlook

Now that gold has corrected in line with other assets, what is in store for the metal? Let's take stock of the fundamentals.

Recent scepticism about gold is based on the argument that investment demand for the metal will fall and the big exchange-traded funds in gold will sell the metal, if prices correct. There are no signs of this at present. The US SPDR Gold trust (the largest gold-backed ETF in the world) has actually seen no material drop in its gold holdings since November. Should investors bail out, central banks may still step in. Early this month the central bank of Korea purchased gold. This could be helped by uncertainties in the global market and dollar and euro having their own worries. Also, the fears of inflation in the US, the UK and Europe on quantitative easing in the coming year may support gold's price. World jewellery demand fell by 10 per cent in the third quarter of 2011 led by India. An encouraging sign here is the increasing demand from China, whose jewellery consumption rose 13 per cent in volume terms the September quarter.

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