In our April 2013 column, we pointed out that the commonly held belief – that South Africa has been and is a commodity-based economy which is closely aligned with the fortunes of gold – had some serious flaws. The fact remains that one of the most common fundamental reasons given for the rise and fall in the rand is its close correlation with the gold price. The fundamental theory is that, because South Africa is a commodity-based economy, the rand exchange rate has a high negative correlation with gold. So when the gold price rises in dollar terms, the rand will strengthen against the dollar, and when gold drops in value, the rand will weaken. But what is the reality? Let us show you. The inserted chart reflects the historical rand exchange rate and gold price against each other, colour-coded with positive, negative and negligible correlation. This is a very revealing picture. In reality there is no consistent historical correlation between gold and the rand. As can clearly be seen, the past 14 years show extended periods of both positive and negative correlation, and at times virtually none at all. Using a 30-day rolling return on both markets, the negative correlation between these markets since 1999 is just 32%. We see no predictable nature and nothing that suggests cyclic movement or repetition in the relationship. Clearly this theory is just that – a theory. And with an accuracy of just 32%, one which has little credence. Using gold to forecast or explain rand movements is clearly not a valid methodology. From experience, the most reliable method to predict future rand (or any other) market movements, is to analyse the patterns in that market itself. These patterns are a perfect reflection of the mass psychology active in that market, and because we as humans are creatures of habit (and tend to make the same decisions under the same circumstances), these patterns repeat themselves over and over again. Through understanding the laws that govern these patterns, one is therefore able (once we have determined where we are in such a pattern) to predict with a high degree of accuracy where the current pattern is likely to be heading next, based on how the investor herd has reacted in similar circumstances historically. Intriguing, and powerful stuff. www.ForexForecasts.co.za/go/ ZAROutlook INSERT & CAPTION In reality there is no consistent historical correlation between gold and the rand. – James Paynter
