Gold To Break Away From Equities

|
 |  Includes: GLD, IAU
by: Emanuel Balarie

I have been watching gold like a hawk this week. The main reason has to do with the fact that the way it has been trading has boggled the minds of many gold investors. Specifically, I am referring to how gold prices have moved step by step with the equity markets.

As you can see from the following chart, gold has pretty much tracked the S&P in terms of its movement. When the market rallies, gold rallies. When the market sells off, gold sells off. Even the bullish fundamental news that has come out this week (higher than expected inflation) has failed to push the price of gold above its range bound trading (640-660). So the question becomes…is this a new trend? Or simply a short-term reaction to what has happened in the market over the last couple of weeks. In other words, will gold continue to track the market or will it finally decouple and trade by its own merits?

GRAPH50

This question is magnified by the fact that I believe we are still in the infant stages of this stock market decline. If the stock market continues its decline and gold continues its correlation to the equities markets, I would expect the price of gold to break below the range and drop to the 590 to low 600’s level. On the other hand, if we see gold decouple from the equities market, the upward movement in gold will be sharp and quick.

As of now, investors in the gold market continue to keep an eye on the stock market. Only time will tell when this short-term trend will end. However, I do believe that the moment we see gold move sharply upward (and above the 660 level) while the stock market has a sharp decline, this will likely symbolize this decoupling. Fund buying will likely come in around those levels and investors will once again realize that gold is not only a value play, but an irreplaceable asset for their portfolio. Until then, I am keeping a cautious watch on the gold market. Long-term and intermediate-term fundamentals remain in place, but the short-term correlation with the stock market is quite interesting.

Inflation and Gold

Inflation numbers came in above expectations, surprising many Wall Street analysts. The US producer price index grew by 1.3% in February, the biggest amount in 3 months. Economists were expecting only a 0.5% increase. The core producer price index, which doesn’t include food and energy prices, also grew by twice the expected amount (0.4%). On the consumer side, the US consumer price index grew by 0.4% in February and core CPI increased by 0.2 %.

With these numbers, there is now renewed talk about inflation. Many on Wall Street had incorrectly surmised that inflation was moderating and no longer a concern. The above numbers clearly show that this is not the case. In fact, I believe that the inflation problem is a bigger problem then most acknowledge and even bigger than the problems surrounding the slowing economy (yes, I do believe there is a strong likelihood of stagflation).

In my opinion, if the Fed does not act accordingly and raise rates, they will only prolong the inflationary problem that will get exponentially worse. I have repeatedly stated that the problem surrounding the Fed and their vigilance to fight inflation is that they are not focusing on the right information. Relying on the core CPI data to determine whether or not we have inflation is similar to a doctor who will not prescribe medication (even though the symptoms are fairly obvious) until the lab comes back a couple weeks later with the reports. Now, I don’t want to offend any in the medical field, but the point I am trying to make here is simply that waiting until higher prices finally transpire in goods and services will only allow further liquidity to flood the market. The Fed should look more closely at the money supply and what brought us this rising price environment, rather than at lagging indicators. Raising rates, not cutting rates, should be the Fed’s next move.

Of course, whether or not the Fed decides to raise rates is still to be determined. What is clear, however, is that gold will benefit from an inflationary environment. While inflation erodes savings and wealth, gold has historically preserved wealth. In addition, it is perhaps the best hedge against inflation.

Disclosure: Author has no position in any of the above-mentioned securities