As I write these words June WTI crude oil futures are up 2.4% to $70.68/barrel while June gold futures are down $2.50/ounce to $1311.20. Tonight's futures market action is just the latest example of an interesting trend that has developed during the last couple of months:
WTI crude oil vs. gold (top) with rolling 20-day correlation (bottom)
The correlation between gold and crude oil has gone from solidly positive in mid-April to solidly negative (-55%) today. I believe this negative correlation between gold and oil actually makes a lot of sense right now and I'll tell you why. With the average national gasoline price once again sneaking up on $3/gallon, each incremental increase in the price of oil is likely to have an increasingly positive impact on consumer price inflation. With the CPI now pushing up towards the upper end of the Fed's desired range, the Fed is likely to be increasingly sensitive to changes in the CPI, and in turn movements in the oil price.
Faster Fed rate hikes are more likely to result in higher real interest rates which we know historically serves as a strong headwind for the gold price (negative real rates are a positive for gold, higher, or more positive real interest rates are generally a negative for the gold price). RBC recently pointed out that the recent increase in the likelihood of a Fed rate hike in June (from 77% on March 21st to 92% currently) has helped to weigh on gold prices (gold dropped from $1350 to $1310 over the same time frame):
Gold bulls will want to see oil prices cool off for a while (stabilize in the high $60s or pull-back a bit), however, a large decline in oil prices is also likely to be a negative for gold. As it stands now it looks like the worst case scenario for gold would be a continued strong rise in oil prices which could trigger a much more aggressive Fed rate hiking cycle - interestingly enough such a scenario would also likely sink stocks (S&P 500 etc.).
An interesting options bet might be to buy OTM (out-of-the-money) June or July puts on the S&P 500 while also buying OTM June or July calls on GLD. From my estimation the odds of either a large decline in stocks OR a large rise in gold during the next couple of months is probably a bit better than the market is currently pricing in.
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