Thursday, January 19, 2012

Divergence of gold price and sovereign CDS spreads

Recent Sober Look post discussed the apparent "dislocation" between US equities and treasury yields. Here is another potential dislocation. The chart below shows gold price plotted against the 5-year SovX Western Europe (SovX WE) spread. SovX WE is an iTraxx CDS index comprised of 15 names from the Eurozone region plus Denmark, Norway, Sweden and the UK.

Gold price vs. SovX WE spread (Bloomberg)

As expected the widening in sovereign CDS rose in tandem with gold price which was driven by demand for "safe haven" assets. That relationship broke down when gold began to trade more like an industrial metal such as copper. Some of the dislocation in gold was driven by fears of a sharp economic slowdown across Asia, typically a big buyer of gold.

There are two events that could put this relationship between gold price and SovX WE back in line. One is a severe crisis in the eurozone, such as a disorderly exit of Greece from the euro. The other (and the two are not exclusive of each other) is an acceleration of monetary or fiscal stimulus in China and India. Both nations have shown willingness to use a variety of tools to avoid a slowdown (more on India later).

The non-zero probability of these events should provide some support for gold prices, at least in the near future.
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