Market Volatility Underscores Gold's Attractiveness

 |  Includes: GLD
by: Clif Droke

The one constant this year has been market volatility. Stock market volatility, including for the mining stocks, has waxed and waned throughout 2011 but has been recurrent more this year than in the previous two years. After a brief period of dormancy, volatility has once again been on the rise.

The CBOE Volatility Index (VIX) shows the recurring theme of volatility throughout the year to date. The VIX, which measures the so-called “fear premium” and is a good indication of increased fear among options traders, has recently spiked, as you can see in the following chart. This VIX “rally” was in response to the pronounced fear over the U.S. debt debate as well as debt fears in the eurozone. Traders were visibly spooked by the high-profile media discussion of the consequences of the failure of Congress to raise the debt ceiling and of a possible U.S. bond downgrade. These fears were averted, but until now volatility has continued to dominate the equities market as the currently high level of fear has yet to recede.

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Aside from the latest flow of bearish news headlines pertaining to the debt problem, market volatility is both a cyclical and a structural problem. Volatility has increased in recent years as we’ve gotten closer to the bottom of the 120-year Kress Cycle, which is the master long-term financial/economic cycle of inflation/deflation. As we head closer to the fateful year 2014, when the cycle finally bottoms, we’ve witnessed at least two key cyclical events: The 12-year cycle peak in 2008, which exacerbated the credit crisis, and the 10-year cycle peak of late 2009. The six-year cycle component of the 120-year cycle, which is the last of the long-term cycles currently up, is scheduled to peak in late September/early October this year.

The downward force of the 120-year cycle is converging with central bank attempts at fighting deflation through increasing money and credit. This is what is creating much of the volatility as the cyclical downward force of the Kress cycle is converging with the counter-cyclical force of quantitative easing, et al., to create a massive cross-current in the financial market. Eventually, though, the downward force of the 120-year Kress cycle will simply overwhelm any and all attempts at government intervention in the financial market economy. In the end, the forces of nature always prevail against human efforts at reversing nature’s force.

Another reason for the increased volatility of recent years can be found in the structure and makeup of today’s financial marketplace. Market alpha has been waning and is being augmented with beta. Hedge fund managers are pressed for returns and are enhancing beta, which is reflected in increased volatility. Unfortunately, too many of the managers are young, inexperienced and reactionary. This has resulted in the increased volatility not only on a weekly basis but sometimes on a daily basis.

Volatility is a manifestation of fear among market participants. Fear is a reaction to the unknown. Fear and uncertainty are major drivers of the gold price from a long term standpoint. Investors have a visceral instinct to run to gold as a financial safe haven during times of uncertainty. When fear surpasses greed as the dominant emotion among investors, as it has since about 2001, it serves as a powerful negative force against equities, but also as a strong driver in favor of gold. The run-up in the gold price since volatility first began manifesting is one testament to this.

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Indeed, the yellow metal has benefited for the most part from the extreme fear that is plaguing investors. Gold has risen to a series of new all-time highs in just the last few days, even making a new intraday high on Thursday, Aug. 4, before closing with a small loss. Gold has overstretched from its key short-term and interim trend lines, however, and could use a correction before continuing its main upward trend. The main consideration for gold is that it is a fear hedge and, with all the fear that continues to dominate the economic headlines, gold should continue to have plenty of fuel for its long-term bull market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.