The vicious correction in precious metals-related stocks has been especially disheartening for fundamentally minded gold bugs because it occurred concurrently with a rally in stocks. Not only was short term money lost by holding precious metals stocks, but short term opportunity was also lost by missing a rally in stocks. Iím figuring that about now, investor gold bugs need some chicken soup for their soul. (No such soothing is provided for short-term speculators Ė it is even rumored that they have no soul!) So look on the bright side, because the reasons to hang in there and stay long precious metals are many.
The Decoupling of Gold and Stocks
Remember last winter and early spring when you were doing well with all of your gold stocks and your account value was rising? Didnít it bother you that your neighbors were making similar gains in the US stock market? As a contrarian, werenít you a bit perturbed that while you did your homework which told you that paper currencies around the world were going to lose value, your next door neighbor was doing just as well by acting on stock tips from low brows on TV? Well, in recent weeks something positive happened in this regard. That is, the behavior of stocks and gold decoupled. Now they no longer act in the same manner, and precious metals are free to go in opposite directions as stocks. With your account balance hurting and your neighbor crowing louder than ever since stocks recently went up while precious metals went down, there is a bright side, and that is the recent decoupling of stocks from gold. When reality sets in (it always does), precious metals will rise while stocks will fall.
Some people seem to be lucky when it comes to the financial markets at this time of year. And so it is this year Ė those folks with an interest in the US publicís false confidence in their economy always seem to get lucky in the fall. Those Asianís who produce the chattel for the US consumers will benefit from the wealth effect produced by the stock market this Christmas season. This is quite lucky for them as the home ownership wealth effect finally seems to be dying down and the stock market can handily take the wealth effect baton. Lower long term interest rates will benefit those who would benefit from more US consumer debt. Itís the same people that buy the US debt that profit from the behavior of the US consumer. The financial institutions also get a cut and indeed, they are lucky too. Those companies and governments that benefit from incumbent politicians remaining in office also seem to be getting lucky this fall since the wealth effect benefits incumbents. They are lucky in the same manner that Moe Green was unlucky in the Godfather.
Well, as a gold bug, maybe you will have your lucky time too. Iím guessing in early October you will feel luckier. If not then, after the first Tuesday in November you may feel luckier about your portfolio.
This Happened Before
Corrections in the precious metals such as the one that occurred over the last couple of weeks have happened before. This is behavior that occurs within the context of bull markets. If you have practiced good money management while not risking too much on a single theme, you can easily sit out a correction such as this, until fundamentals result in a resumption of the bull market.
This Never Happened Before
Throughout history, paper currencies eventually have failed. Itís a long term proposition and you have heard it all before, but this too shall pass.
The chart below is this analystís Elliott Wave interpretation of the gold bugís index ($HUI). The correction, viscous as it appears from close up, it just a blip up in the context of a secular bull market.
Bonds and the Inverted Yield Curve
The rally in bonds and the inverted yield curve suggests that there are deflationary pressures in the economy, and an economic slow down is in progress. Even though it is not being emphasized in the normal business news channels, there is strong anecdotal evidence of an economic slowdown. AutoNation CEO, Mike Jackson articulated this clearly and concisely on CNBCís Squawk Box Wednesday morning.
Will deflation hurt precious metals stocks? In the deflationary period following the 1929 crash, gold stocks did quite well. The linked article provides some insights.
If the case for precious metals during deflationary times is good, the case during inflationary times is great. With the amounts of outstanding government and US consumer debt out there, deflation would devastate the economy. When it is dollars you owe, you need dollars to be less valuable in the future. If they become more valuable, then it becomes more difficult to pay back the loans. The most likely outcome is (more) Fed-induced inflation. It wonít take the exact form of Mr. Bernankeís helicopter money; but the effects will be the same and this will benefit precious metals.
The correction in precious metals and energy stocks has a lot of former bulls jumping off of this bandwagon and on to the ďhot stockĒ bandwagon. Sometimes, it takes a true contrarian to make the big money. Those holding their position in a secular bull market are the true contrarians. More on this in a future article.
Following the recent rally, most of the major indices sit near important technical levels. Key levels to consider are 50 on the Dow Jones Transportation ETF (IYT), 40 for the Nasdaq 100 ETF (QQQQ), and the May highs for the S&P 500 and Dow Jones Industrials. The HUI Gold Bugs index is even approaching its previous correction low at 275. Whether these key technical levels are taken out will determine whether this stock market rally is something of long term substance or just an early and profitable year end rally. Certainly with the stock traderís almanac on the best sellers list, there was the opportunity to fool a lot of seasonal traders. The market has been one where it has been profitable to play the wives tales from the long side and ignore them from the short side. And of course, this is factored in too. So when October approaches, once again there will be many folks waiting for their given year end rally. If it doesnít come, there will be a lot of people fooled. For now, itís the important technical levels that require attention and deserve respect.
It seems as if everyone is on board the bond and stock market rally, but with the utilities making what appears to be a double top, may be something is amiss in the bond market.
Have a great evening.
James J. Puplava Financial Senseô is a Registered Trademark
P. O. Box 503147 San Diego, CA 92150-3147 USA 858.487.3939