Wednesday, June 27, 2007

Japanese Stocks and Gold Stocks

This next chart shows another interesting intermarket relationship. Japanese stocks and gold stocks would appear to have nothing in common. I mean, what does Japan have to do with gold. Well, if you look at the chart below, it is fairly clear that they are in fact tightly correlated.

In the above chart, the first section is a graph of the Japanese Ishares ETF, ticker symbol EWJ. This exchange traded fund contains a basket of various Japanese companies. The graph on the bottom shows the XAU, which I discussed in a previous post. As you can clearly see, the 2 charts tend to peak and trough at the same time, as shown by the blue lines.

This chart is very useful when a divergence developes between the 2 charts. In other words, one chart begins falling, and the other continues rising. This sort of thing happened near the beginning of November, 2006. The Japanese Ishares started falling, but interestingly, the XAU kept grinding higher. This diveregence was corrected by the XAU falling shortly thereafter. In this way, I feel that EWJ gave a warning signal when it began falling while the XAU was rising.

The reason that there is a relationship between the two has to do with inflation. During the 1990's Japan was couping with a serious bout of deflation. This deflation spread around the global economy, and was a negative influence on commodities. However, ever since the year 2000 or so, the Japanese economy has picked up, and these deflationary forces are beginning to subside, and inflationairy forces are starting to reasert themselves.

In other words, the Japanese market is barometer of the Japanese economy's health, and the health of the Japanese economy is a barometer of inflation, and gold rises when it detects inflation.

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