Market Correlations: Why the Dollar, Gold, Oil and Stocks Connect

When petrol prices jump, you usually feel it everywhere a few weeks later: delivery fees, flights, even the weekly shop. Nobody tells those prices to move together, but because they're connected, they tend to. Global markets work exactly the same way.

In this article you'll learn, in plain words, what correlation means, the five most important links between markets, how those links change, and how to use them in your own trading.

What is correlation?

Correlation is a number between minus 1 and plus 1 that shows how closely two markets move together:

• Close to +1: they usually move in the same direction; when one rises, so does the other.
• Close to 0: there's no real relationship.
• Close to -1: they usually move in opposite directions; when one rises, the other falls.

Two important points right away: correlation means "usually", not "always". And it doesn't tell you which market is the cause and which is the effect.

Five links every trader should know

1. The dollar and gold

Gold is priced in dollars. The World Gold Council says gold has historically tended to move against the dollar. Even more interesting, the relationship isn't symmetrical: a weaker dollar usually lifts gold more than a stronger dollar pushes it down.

2. Interest rates and currencies

When a central bank raises interest rates, money usually flows into that country for the higher return, and its currency tends to strengthen. Gold feels this too: it pays no interest, so when rates are high, holding it is less attractive.

3. Oil and inflation

Oil isn't just fuel for your car. A research note from the Federal Reserve explains that higher oil prices raise production and transport costs across the economy, those costs get passed on to food and other goods, and people start expecting more inflation. Higher inflation means a higher chance of rate hikes, and that feeds through to currencies and stocks.

4. Stocks and bonds

For years the rule was that when stocks fell, bonds usually rose and acted like a shield. But according to T. Rowe Price, in 2022 the stock-bond correlation turned strongly positive, something not seen for more than two decades. The reason: high inflation and fast rate hikes dragged both down together.

5. Stocks and crypto

Before 2020 many people saw crypto as separate from the stock market. But the International Monetary Fund showed that Bitcoin's correlation with the S&P 500 rose from 0.01 in 2017 to 2019 to 0.36 in 2020 and 2021. So when Wall Street gets nervous, crypto now tends to wobble along with it more than before.

A real chain reaction: 2022

2022 showed how these links fall like dominoes:

• Oil prices spiked and inflation worries grew.
• The Federal Reserve raised rates quickly, at a time when US inflation was at its highest in more than 40 years.
• Stocks and bonds lost money at the same time, something that hadn't happened like that in over twenty years.

In other words, an event in the oil market travelled through inflation and interest rates all the way to stocks and bonds.

Practical example: one idea, double the risk

This example is hypothetical and the numbers are simplified.

Say you open two trades and think you've spread your risk:

• Buy gold, risking 100 dollars.
• Buy EURUSD, risking 100 dollars.

But look closely: both are really the same bet, a bet on a weaker dollar. If one piece of economic news strengthens the dollar, both trades will probably lose at the same time. Instead of two independent 100 dollar trades, you've effectively placed one 200 dollar bet.

The fix: either halve the size of each so your total risk on the "weaker dollar" idea stays at 100 dollars, or pick just one.

How to use correlation in your trading

• Avoid doubling up: before opening a new trade, check whether it points the same way as the ones you already have.
• Use it as confirmation: if you're buying gold while the dollar is getting stronger, you're sailing into a headwind; trade more carefully.
• Watch the market that moves first: sometimes one market reacts earlier, such as index futures or the dollar. Keeping an eye on them helps you avoid surprises.
• Re-check from time to time: correlations change; a number that was true last year may not be true now.

Common mistakes

• Treating correlation as a law: "gold always moves against the dollar" isn't true; usually, not always.
• Missing the doubled risk: several trades in the same direction are really one big trade.
• Confusing correlation with cause: two markets moving together doesn't mean one is pushing the other.
• Relying on old data: 2022 showed that relationships lasting decades can flip.
• Only watching one chart: if you only look at your own market, you miss the dominoes falling behind the scenes.

Practical checklist

• I know which markets have a strong link with the one I'm trading.
• Before a new trade, I've added up my total risk on one idea.
• I glance at the dollar, oil and index futures every day.
• I've marked inflation and interest rate news on my economic calendar.
• I remember that correlation means "usually", not "always".

Frequently asked questions

Where can I see correlations?

Many platforms and analysis sites have correlation tables. Even without one, putting two charts side by side shows you the general relationship.

Is negative correlation useful for hedging?

It can be, but carefully. A relationship that's negative today may turn positive tomorrow, just like stocks and bonds in 2022.

Why do correlations change?

Because economic conditions change. For example, when inflation is high and rising, stocks and bonds behave differently than in low-inflation periods.

Which relationship matters most for a beginner?

The dollar's link with everything else. The dollar sits in the middle of most markets; if you know what the dollar is doing, you've got half the picture.

Wrapping up

Markets are linked like carriages on a train: the dollar, gold, oil, interest rates, stocks, bonds and crypto. Correlation helps you spot hidden risk, choose your trades better and avoid being blindsided by the news. Just remember these relationships are alive and they change.

To learn step by step, check out the free courses and take a look at the pro tools in software.

Adapted from: World Gold Council, Federal Reserve, T. Rowe Price and IMF

Trading involves a significant risk of loss. This article is for education only and is not financial advice.