Consumer Sentiment Index

People are emotional beings and herd animals at the same time, so sentiment is a key factor in many markets. In particular, sentiment is an important driver for the gold prices, as the yellow metal does not bear any yield and its industrial use is limited. So it is difficult, if not impossible, to calculate the bullion’s fundamental value – and this is why the sentiment is so important in the precious metals market.

The latter gauge is developed from the nationally representative monthly telephone survey of a minimum of 500 households (which is not a very large sample, given the US population size). Each survey contains about 50 core questions which cover three broad areas of consumer sentiment: personal finances, business conditions, and buying conditions The consumers are asked to assess how they view prospects for their own financial situation, how they view prospects for the general economy over the near term, and how they view prospects for the economy over the long term. The index is calculated by subtracting the percentage of unfavorable consumer replies from the percentage of favorable ones, and it is normalized to have a value of 100 in Q1 1966.   

Consumer Sentiment Index and Gold

The consumer sentiment index is important gauge as it provides an indication of future consumer behavior. Usually, households save more and spend less when they become more pessimistic about the economic outlook. Conversely, people save less and spend more during economic booms when the sentiment is high.

This is why the Consumer Sentiment Index is included in the Leading Indicator Composite Index published by the U.S. Department of Commerce – its decrease may signal a weak consumer demand and, thus, a sluggish economy. Therefore, gold prices should be correlated negatively to the consumer confidence. Indeed, there might be a grain of truth here. For example, as the chart below shows, both great gold bull markets occurred during the periods of subdued consumer confidence.

Chart 1: University of Michigan’s Consumer Sentiment Index (red line, left axis) and gold prices (yellow line, right axis, London P.M. Fix, in $) from March 1978 to March 2019.

Consumer Sentiment Index and Gold Chart

However, the correlation coefficient between the consumer sentiment index and the monthly average of gold prices is just -0.27, which indicates a relatively weak link between the both variables (although it is stronger than the one between the consumer confidence index and the price of gold).

Another problem with the consumer confidence is that it may be actually a lagging indicator. The reason is that consumers’ sentiments change in response to economic developments such as the business cycle. They get more pessimistic during recessions, when they or someone they know become unemployed, and they become more optimistic during booms when their real incomes rise. Take a look at the chart above once more. As you can see, the consumer sentiment index plunged in 1980, 1990, 2001 or 2008 only when the recessions were already well advanced. It means that the usefulness of the consumer sentiment index for gold investors is limited – it may only confirm a pattern that is already occurring.

Last but not least, the chart above also shows that in summer 2011, the index gave a false positive signal, which could mislead the precious metals investors, as it plunged to a level seen during the Great Recession, although the economy continued its expansion. That was the time of Arab Spring, Fukushima, the Greek crisis and U.S. credit-rating downgrade below the coveted AAA level. The leading indicators also looked like rolling over, it was the time of the double-dip recession talk. Little wonder that the consumer wasn’t feeling upbeat exactly.