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Precious metals investment terms A to Z

Correlation Matrix

The Correlation Matrix is a table that contains correlation coefficients among several markets (including precious metals) in different timeframes.

Eric asks:

Eric, Jill and John have just finished watching a DVD of the Hollywood science fiction film “The Matrix” with Keanu Reeves.

Eric, the Beginner

Eric, the Beginner

I know that investing is precious metals is no science fiction but didn’t you mention some sort of a matrix to me a few weeks ago?
John, the Trader

John, the Trader

You must mean the correlation matrix.
Eric, the Beginner

Eric, the Beginner

Yeah, that’s the one. Can you explain a bit more about it?
Read the whole discussion

Correlation Coefficient

We have prepared a video in our Multimedia section about gold and silver correlations that explains the logic behind the Correlation Matrix, so if you haven’t already seen it, we suggest that you take a few minutes to do so. Being familiar with the correlation coefficient will also make the following much easier to understand.

Correlation Matrix

Below you will find a graphic that shows the correlation matrix. The first column shows assets between which the correlation coefficient was calculated. The red row indicates the number of days that were used to calculate the correlation. Beneath the table, you can find an info box which gives you ready interpretations on given figures when you hover your cursor over them. It explains the strength and direction of the correlation coefficient, so you do not have to figure it out on your own.

The most important feature of the correlation matrix is that it shows you short, medium and long term correlations between assets at the same time. Consider the first row (Gold/Silver). You are probably not surprised that the relationship between Gold and Silver is very strong and positive in every period, which means that the prices of these two assets move in the same direction. We have not learned anything new here, but we have a strong proof for this relationship, we do not need to rely only on our intuition or suspicions. We can safely conclude that what is bullish for gold is likely to be bullish for silver.

However, look at Gold and S&P (row 3). You may notice that currently there is a strong positive correlation (not as strong as in case of gold and silver, but still strong), but in the long term (1500 days period) the correlation is negative. That gives us some useful information: we see that recently these markets have been moving in the same direction. However, from a longer-term perspective, they do not. So that means there were some significant changes as far as the nature of that relationship is concerned.

The important point worth noting is that not only do the prices of various securities and market indices change, and should be analyzed in different timeframes, but the same applies to the ways markets influence each other. The important thing here is that price trends and correlations don't necessarily change at the same time.

Gold & Silver Correlations

Therefore, when we are getting closer to a particular turning point in gold, silver or mining stocks, we can check to see what influence other markets are exerting on precious metals at that particular moment. This will indicate what might be a catalyst for either a breakout or a breakdown, which consequently increases our chances of making the correct decision. In other words, analyzing prices of precious metals along with currencies and stocks plus the correlations among them should provide us with more information about future prices and trends, than analyzing precious metals alone.

Generally, if you're a long term investor who wants to analyze the long term trends, you should use the last two columns that are created by calculating data from the previous 750 trading days (about 3 years) and 1500 days (about 6 years). On the other hand, day traders should focus on the 30-day column or even the 10-day one (although this one is not statistically significant, but that is another matter).

Summary

The correlation matrix is a useful tool that shows you which market you should be paying attention to in order to increase the odds of making a correct call on precious metals.

If you want to learn about investment tools that can increase these odds even further, please check the Investment Tools section of our website.

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