Back in mid-April, I postulated that gold’s decline was the catalyst that would drag down other markets.
Technically, gold had been in a weakened condition since its high in 2011. Without delving into the minutiae of a price chart analyst, when I saw a gold chart, I saw the end of a long bull run approaching. My thinking is also governed by the excess credit flowing into cones of investment. Credit naturally flowed into the gold cone. At some point, let’s call it a point of inflection, the market (those humans) realize that something is amiss and the confidence expressed in that investment begins to dissipate. This is what I saw in gold, confidence dissipating. When the confidence dissipates further, it leads to panic selling which is what we witnessed on April 12th and 15th.
Given this as a backdrop for other markets, what has happened since then?
The U.S. Treasury bond market made its most recent high 2 weeks after my article. Since the high on May 1st, the bond market has tumbled and with it the hopes and dreams of future homeowners anticipating low mortgage rates. Rates are still historically low though I predict they will not remain at these levels. The municipal bond market has seen yields rise sharply (lower prices) and the recently hailed junk bonds have similarly seen a rise in yields (lower prices). For some pundits, the higher yields/lower prices are justifications around a stronger economy. Here is the problem with that thesis. The economy, and more importantly borrowers, is/are very fragile and higher rates will accelerate non-payment and eventually precipitate default. For the U.S. government, this will be catastrophic with so much debt to roll over.
The Dow Jones Industrial Average continued its ascent for another month after my posting and made its high on May 22nd. The S&P and Nasdaq did the same. The Dow Jones Utilities index made its high on April 30th. All of the aforementioned indices are comfortably lower than their recent highs. The Russell 2000 index followed a path similar to the Dow though it has managed some strength in the interim. For good measure, the Nikkei, which experienced an impressive ride for most of 2013 on the back of Abenomics, fell a spectacular 20% in less than a month. Across the pond in London, the FTSE index fell 11% from its high (yes you guessed it on May 22nd) before a mild recovery this week.
Predicting the demise
Using gold as a barometer for other markets made sense in light of the flow of credit to the “cones” I mention in Escaping Oz. Gold is no different than other investment categories in that credit will eventually find its way to this vehicle. It was not a matter of the Fed printing money or the public’s perception of the demise of the U.S. Dollar (USD). Gold was going up in price because those with money/credit wanted to buy it. The reasons need not always be rational. Investors are not always rational and excessive credit creation tends to exacerbate irrationality.
For those keeping score at home, since its September 6, 2011 peak, gold is down some 36%. In the period from that peak to now, we have had continued “money printing” and wide government deficits. How is it possible that gold declined? A sociological sign that gold was at or near the top was the emergence of places looking to buy gold. The ultimate confirmation from me was seeing a person with a sign draped over their body walking around advertising an offer to buy the yellow metal.
Where do we go from here?
Gold is probably oversold at this juncture so it will be reasonable to expect an upward retracement. This move will not be the resumption of a bull market but merely an interruption of a longer-term move. The next level of support lies in the $1,040 range representing important trading prices from 2008 and 2009. As a parenthetical note, gold declined for most of 2008, the year of the financial crisis.
As far as the equity markets are concerned, let emerging and Asian markets be your guide. These markets have never reached the tops previously achieved in 2007 and are exhibiting great weakness. The British FTSE index, mentioned earlier, should also cause concern. Look for the U.S. markets to continue their downward slide. I fear explosive moves to the downside given the psychology which underpinned the rise of the Dow and S&P. For many investors, there was no other viable place to put their money. Yields were simply too low so risk be damned. That damnation will come back to haunt them.
Jim is the author of Escaping Oz: Protecting your wealth during the financial crisis.