September 21, 2011

Gap Between Gold and Stocks Widening

Negative correlation is heightened in turbulent times, says FactorShares CEO

Divergence in the direction of gold futures and the S&P 500 has reached levels not seen since the Lehman Brothers collapse in 2008, a possible indication that investors are preparing for further market turbulence. Stuart Rosenthal, CEO of Factor Advisors, says the three-month correlation between gold and large U.S. stocks is now minus-0.52% and the gap seems to be widening.

One of the New York-based firm’s flagship products, which provide long-short ETFs used by investors seeking to leverage the spread between two market segments, is the FactorShares 2X Gold Bull/S&P 500 Bear ETF (NYSE:FSG), which seeks to capitalize on the historic inverse relationship been gold and large-cap stocks.

stuart rosenthal“We’ve crunched this data going back decades and a hundred-plus years,” says Rosenthal (right). “The correlation is anything but stable; so the graph moves from one extreme to another. But based on 180 years of data, the correlation [between gold and large U.S. stocks] is roughly zero. Gold is running independent of stocks.”

And this independence just got more interesting in the past three months because of the widening negative correlation, a pattern which Rosenthal says has historically “coincided with various pullbacks in the market.”

He cited the flash crash in 2010, the Middle East uprising beginning last December and the recent downgrade of U.S. sovereign debt by Standard & Poor’s as examples of turbulence that sent gold and large-cap stocks in different directions. “We’re observing this inverse relationship; it’s related to gold’s safe haven status. It’s kind of like U.S. treasuries: gold is a risk-on, risk-off [market play].”

FSG was up half a percent in midday trading Wednesday; it is up 67% since it began trading in February of this year.

Rosenthal expects the negative correlation trend to persist in the immediate future based on the performance of near-dated options on the firm’s FSG ETF. “Based on our market observations drawn from the options for FSG, option market participants are voting that that negative correlation will persist in the short run. One may infer that a heightened volatility for stocks may continue,” he says.

The Factor Advisors CEO did not express a view on how gold or large-cap stocks would perform. “We only go so far as to say that the options market was voting that if stocks yin, gold might yang. The options on FSG are validating the short-term continuation of that negative relationship,” he said.

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