In a nutshell, this clearly describes what has occurred throughout this decade. Consumers have continued spending in the midst of declining savings. Housing prices have escalated even as incomes and job growth have failed to appreciate. Manufacturing has left the country, inflation has soared, and our budget and trade deficits have increased at an unbelievable rate. Yet in the midst of all of this the “goldilocks” phrase has been tossed around, consumers have lived outside of their means, and individuals have had a false sense of economic security.
What has transpired in the last several months should serve as a wake-up call. The housing slowdown, sub-prime debacle, and equity decline should not have taken anyone by surprise. Yet it did. The escalating tensions with Iran should not surprise anyone. Yet it has. Last night, oil prices jumped to $68/barrel as rumors about an attack by Iran on a US vessel sent prices higher by $5 in a short period of time. While this ended up being a rumor, it is not a rumor that Iran took hostage 15 British sailors. Oil prices should have jumped higher on that news alone. Yet it didn’t.
This again shows you the complacency that is still in the market. Any way you look at it, taking 15 British soldiers hostage is a big deal. In any case, whether it is complacency over geopolitical tensions (not only with Iran, but also with North Korea and Venezuela) or complacency about the US economy and the housing market, investors should be aware that this lack of regard will get them nowhere. At best, having this outlook in the midst of convincing economic data and news is hopelessly optimistic. At worst, it may lead to financial ruin.
Gold Breaks Away From Equities
About a week ago I stated that gold has been tracking the stock market.
As you can see, 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?
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.
This week we saw gold break through the 660 level and also saw the market head sharply lower as gold has remained strong. Even as I write this, gold is up about 5-6 dollars and the S&P is down about 12 points. [Update: gold is selling off and the stock market is rallying]. While there will likely still be moments where gold will track equities, gold is now clearly trading by its own merits. Oil is up, tensions with Iran are escalating, and the recent sell-off and consolidation that occurred in the gold market is setting up for a relatively quick move above the $700 level.
In addition to the fact that gold is decoupling from the equities market, there are several other key reasons why I believe we will see this quick move up to $700.
1) Gold has broken out of the 635-660 Range
2) Middle East tensions heating up
3) Sharp rise in oil prices
4) Dollar weakness continues