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Gold and Small Caps, A Broken Relationship

Chart In Focus
September 24, 2020

Can this marriage be saved?  The normal condition for the past 3 decades has been for gold prices to generally move in step with the Russell 2000/1000 relative strength ratio shown in this week’s chart.  When the two disagree, it is usually the relative strength ratio which ends up being right about where both are headed. 

Since 2018, however, that normal relationship has not been working right.  The Fed’s efforts to boost economic growth, especially in the wake of the March 2020 Covid Crash, have helped to push gold prices higher.  But small cap stocks have not tagged along, and the big mega-cap FANG stocks have absorbed most of the Fed’s supply of additional financial market liquidity. 

That has these two plots moving in opposite directions, and to a degree never really seen ever before.  We did see a lesser inversion of the normal relationship back in 2013-14, when QE3 was underway.  Interestingly, QE3 did not help gold prices like QE4 has, and it boosted the relative performance of small caps.  This time we are seeing it work the opposite way.

The inversion which happened under QE3 did unwind itself, and eventually the two plots returned to their normal strong correlation.  But that ended in 2018, when the current inversion started.

It seems reasonable to expect, given more than 30 years of history, that the two plots are going to get back into strong correlation again someday.  But the unwinding of the current inversion is likely to take a while before that can happen.  As that unwind happens, we should expect gold to give back some more of this year’s gains, and for small cap stocks to start outperforming large caps, at least until the two get back toward some equilibrium state.

Tom McClellan
Editor, The McClellan Market Report

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