Trader’s Narrative

There is an inter-market relationship between bonds and gold which may not be evident at first glance. The reason why the two disparate markets are connected is that they both rely on one factor: inflation. Or the expectation of future inflation.

For this reason, it is very rare for these two markets to go in different directions in the long run. Instead, they tend to dance around each other.

When the market expects future inflation to be higher, gold mining stocks rise and bond prices fall (yields rise). So in effect, by watching one market, we can attempt to gain insight into the other.

Jay Kaeppel developed a simple system to do just that. He looked at the 12 month rate of change (ROC) in the GMI (Barron’s Gold Mining Index) and compared it to the 12 month performance of bond prices going forward. We can substitute the Amex Gold BUGS Index (HUI) for GMI.

When the ROC for the gold index is positive and high, we would expect bond prices to decline going forward (next 12 months). Conversely, when the rate of change for HUI is negative or low, we’d expect it to be a great time to buy bonds. And this is generally what happens according to historical data.

Be sure to check out Kaeppel’s original article on this: Maximizing Bond Fund Profits. You can find it in the Reports & Articles section of my free trading resource “goodies box”.

So what is this simple intermarket relationship telling us now?

Well, as far as I can tell, the bond market and the gold market have decoupled. I can’t seem to find any meaningful relationship between them now. Kaeppel’s article was written in 1994 so it only included data until then. By looking at data from the late 1990’s to today, it seems that the two markets have gone their separate ways. Atleast for now.

For example, in the summer of 2002 when the 12 month ROC for the HUI index was astronomically high, bond prices actually were higher a year later. And in the summer of 2005 (see graph below), when the 12 month ROC was negative (-40%), bond prices actually peaked and were lower a year later.

Click to Enlarge Graph

Strange. As I’ve mentioned before, although the bond market is pricing in future expectations of inflation, other markets, like gold, silver, and the CRB commodities index are breaking down and not confirming this. What to make of this?