Exploring the correlation between the U.S. dollar index (major currencies) and Gold (iShares Comex Gold).

Theory
It is widely known that historically there is an inverse relationship between the price of Gold and the USD. So, what happens when one of the two does not respond as expected to a move in the others price?

Method
If there is a gap of more than 2% difference between the movement in prices of the two commodities we expect that gap to be closed the following day.

Example
01/05/2007: Gold Down 2.45%, U.S. Dollar Index Up 0.22%. Difference = 2.22%
It looks like gold has overdone it compared to the U.S. Dollar Index movement, so we expect gold to drop tomorrow to close the gap.

Results:

01/05/2007
Gold Down 2.45%, U.S. Dollar Up 0.22%,
Expectation: Gold Up Tomorrow
What Happened = Gold Up 0.55% (Profit)
Running Profit = 0.55%

01/12/2007
Gold Up 2.39%, U.S. Dollar Down 0.30%,
Expectation: Gold Down Tomorrow
What Happened = Gold Down 0.32% (Profit)
Running Profit = 0.87%

01/23/2007
Gold Up 2.29%, U.S. Dollar Down 0.11%,
Expectation: Gold Down Tomorrow
What Happened = Gold Up 0.20% (Loss)
Running Profit = 0.67%

02/21/2007
Gold Up 3.04%, U.S. Dollar Down 0.07%,
Expectation: Gold Down Tomorrow
What Happened= Gold Down 0.13% (Profit)
Running Profit = 0.80%

02/27/2007
Gold Down 3.65%, U.S. Dollar Down 0.50%,
Expectation: Gold Up Tommorrow
What Happened = Gold Up 1.11% (Profit)
Running Profit = 1.91%

03/02/2007
Gold Down 3.31%, U.S. Dollar Up 0.03%,
Expectation: Gold Up Tomorrow
What Happened = Gold Down 1.05% (Loss)
Running Profit = 0.86%

08/16/2007
Gold Down 2.30%, U.S. Dollar Down 0.12%,
Expectation: Gold Up Tomorrow
What Happened = Gold Up 0.80% (Profit)
Running Profit = 1.66%

09/06/2007
Gold Up 2%, U.S. Dollar barely moved,
Expectation: Gold Down Tomorrow
What Happened = Gold Up 0.67% (Loss)
Running Profit = 0.99%

11/15/2007
Gold Down 2.78%, U.S. Dollar Up 0.69%,
Expectation: Gold Up Tomorrow
What Happened = Gold Down 0.30% (Loss)
Running Profit = 0.69%

11/20/2007
Gold Up 2.87%, U.S. Dollar Down 0.38%,
Expectation: Gold Down Tomorrow
What Happened = Gold Down 0.44% (Profit)
Running Profit = 1.13%

We were right on 6 out of 10 trades, taking home 1.13% profit for the year. While this certainly isn’t a big amount, the fact that we only had our capital tied up for 10 days counts. Another thing to look at could be whether a stop could be used to reduce our loss on days we’re wrong.