Gold thrives on bad news; that is what we have been hearing for long. What could be worse than another EU country in crisis? With Cyprus under financial stress and "scrambling to secure a new bailout" and from the Russians at that, the gold price should have shot up. That however did not happen. What did happen was that gold stabilized. Gold gained 0.63% in the last three days but is still down 2.67% YTD.
Gold is at three-week high. Is this a sign of an ensuing upsurge in the price of gold? Is the time right to buy gold or for that matter invest in gold equities like SPDR Gold Trust (NYSEARCA:GLD).
The price of gold has fallen 14.50% since early September 2, 2011 and 9.50% since early October 2012. The Cyprus crisis has still not resolved as the situation is a bit complicated. Everyone knows that the Russians (though not confirmed, the rumor is that it is Russian mafia's money) have a lot of money in Cyprus banks and they are even ready to bail Cyprus out from the current crisis. The EU and IMF don't like this. The European Central Bank (ECB) says it has funds to bail Cyprus out but wants any European Union bailout plan to be ready by Monday for it to provide liquidity.
ECB member, Joerg Asmussen said, "We did not threaten (to cut off liquidity), but just pointed out as a matter of fact that we can provide emergency liquidity only to solvent banks and that the solvency of Cypriot banks cannot be assumed if an aid programme is not agreed on soon, which would allow for a quick recapitalisation of the banking sector."
In short, nothing is clear as yet - it is as messy as it appeared on the first day. Gold is already showing signs of safe-haven buying interest and if a solution is not found within this week, there is every reason to expect the price of gold to go up.
In addition, economic data coming out of European Union is not encouraging either. Private sector activity across the EU is slowing down in March and at a faster speed too. The composite purchasing-managers' index (PMI) of the Markit Group dropped to a four-month low - 46.5 against 47.9 in February - much below the forecast of 48.3. Everyone was expecting the European economy to stabilize, if not recover; the fresh numbers point to another quarter of recession in the region.
The Cyprus situation and the weak data emerging from Europe are putting pressure on the euro currency as well as the stock markets. The fact that a situation is developing with North Korea threatening a nuclear strike on U.S. military bases in Japan does not make matters any better.
Taken together, all these are positive indicators for gold market - the safe haven for troubled times.
A bullish stock market and rising value of the U.S. dollar have a negative correlation with gold.
- The Stock Market
The Federal Reserve adopted a monetary policy designed to prop up the stock markets despite a less-than-healthy economy. The Fed pumped trillions of dollars into the system just to convince investors that it was there to protect them from any shocks in future. It created an almost zero interest rate environment to force investors to turn to the stock market for higher returns. The consequence - the Dow Jones Industrial Average, climbed the steep wall to top the October 2007 record.
Source: Google Finance
The S&P 500, which represents the broader market, is yet to breakout above its 2007 high. However, it has broken out above its more recent support levels and consolidated, suggesting that the rally is likely to continue.
The USD Index is above its long-term support level, a technical indicator that suggests a bullish outlook on the U.S. currency. At the same time, the euro is presenting a negative outlook as it has moved below its medium-term rising support level. The Japanese, on the other hand, are taking initiatives to prop up the economy by way of a weaker currency, which is also driving the USD higher.
Seeing Things in the Right Perspective
The Dow and S&P 500 only appear to be moving up and breaching previous highs because we are used to looking at things the way the financial press presents it. They hail such things as historic events. From an economist's viewpoint, the markets are still much below previous highs.
For a realistic and more representative figure, we need to factor in inflation. Once that is done, the Dow's stellar run over the past few years looks more pedestrian. The last inflation-adjusted record for the Dow was on January 14, 2000. It only appears that the Dow has appreciated 22% over 13 years. In fact, if we take inflation into account, it is still 10% below.
So, is the stock market rising or does it still have a long road to traverse before we start using data for establishing its affect on the outlook for gold?
On the currency front, the situation does suggest that the USD Index might move higher. However, the short-term scene is that of it being overbought, suggesting a decline in the near future. Readers wanting to have a better understanding of the current situation from a technical standpoint may want to read this.
Despite the indices surging to get back to their all-time highs, the reality is that many investors have made nothing from this upward move. They still have losses to cover, the losses they suffered when the credit crisis of 2007/2008 resulted in the Dow plunging 34%, the worst in 77 years. The indices are still far from achieving their previous highs in real terms. On the other side, gold has rewarded investors with nearly 119% appreciation in the same period.
An asset appreciating at a rate lesser than the inflation rate actually signifies a real term loss, even if it is a bank term deposit that we are talking about.
Besides the issues discussed above, there is also the case of weak demand from India. Gold is an important gift in Indian weddings, which trigger demand for gold. However, wedding seasons in India are all clustered in quarter 1 and 3.
The Fed has supported the economy for too long now. The Federal Open Market Committee (FOMC), the committee that overseas buying and selling of U.S. Treasury securities, left the monetary policy unchanged this Wednesday. Fed Chairman, Ben Bernanke did not say anything in the press conference that could be construed as market sensitive. The Fed, while sticking to an easy monetary policy for the present, seems to be preparing for winding up the easy money policy. That is what will halt the current uptrend in the stock market forcing large hedge funds to seek shelter in gold.
Taxing bank deposits is an unheard of a solution to a financial crisis but we still heard it being considered. In such a world, gold and its equities present a safe asset class. Gold was and shall always be the ultimate currency. The current weakness in gold is superficial. Investors should take advantage of this dip in the gold price to buy gold.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.