Volatile Markets Move on News and Emotion
By James J Puplava CFP, July 23, 2002
Amex Gold Bugs
Thing vs. Paper
There are three investments in the financial markets, maybe four, that are considered to be the most volatile sectors of the market. They are gold and silver, defense stocks, environmental stocks, and biotech stocks. All of these sectors move on news and emotion. The preparation for war, the break out of hostilities, or a sudden terrorist attack can send defense stocks through the roof. The eruption of Mt. St. Helens or an oil spill can send environmental stocks skyward. A major financial fiasco such as we had in Asia, the bankruptcy of a hedge fund, or a major bank failure can cause investor panic, which sends the prices of bullion and precious metals shares soaring. An announcement of a new miracle drug discovery will send the shares of a biotech stock up like a NASA space launch rising 40-50 percent in a single trading session. These specific sectors over the long run will move on fundamentals but over the short-run they move on emotion.
I would like to suggest to you that we no longer have fundamentally-driven markets. Markets are driven by emotion whether it is greed or fear. It has been that way since the mid-90's. It was greed that drove the markets in the 90's. Instead of fundamentals, investors were encouraged to trade. Gone were the days when investors bought stocks based on value and held on to those stocks until the financial markets recognized that value. When I got in this business in the late 70's I was influenced by the investment philosophy of John Templeton, Ben Graham, and Warren Buffett. They taught me that you buy a stock based on fundamental values and then wait patiently for the markets to realize that value. The average holding period for stocks bought by John Templeton when he was managing portfolios was 3-5 years. That philosophy held true up until the late 80's. After the 1987 market crash, things began to change under the stewardship of Alan Greenspan. When financial crises presented themselves, the Fed's response was to pour money into the markets and reliquify the markets. The standard prescription to any financial crisis was money -- lots of it. Money was added to the system until the financial fires were put out. The consequence of such action was that the markets became more volatile as the new swarm of money danced around the markets looking for a place to land. Wherever that money landed, a bubble was created -- whether it was healthcare stocks, technology, or the Internet.
Trading became more prominent. Instead of "buy and hold," we now had "buy and sold." This culture still permeates much of our financial culture to this very day. In the 90's it became so prominent that professionals were encouraged to quit work and trade for a living. It became so easy to make money in the financial markets that you didn't need a financial advisor. All that was needed was a computer, a trading software program with a data provider, and the rest was easy.
That was the past. Now we have the present. The reason I bring this up is to point out that what we have today is a technical trading and emotion driven market. There are very few convictions that are held today by either bulls or bears. Very few people know where this market is heading. Those that do are in the bear camp. How else can you explain the economic and financial forecasts that have been completely wrong for three consecutive years? Today there are no convictions that are held long-term. When you find them in an individual, they are rare. Most fund managers trade positions like lottery players. Most on Wall Street tell investors to do one thing; while they do the opposite. So we have the volatile markets that we have today because convictions and beliefs are nonexistent. These are shallow markets with investors looking for leadership when none is given. Today we have a technically trade-driven market with no long-term beliefs. To this market, "long-term" can be defined as an hour, a day, a week, a month, or maybe a quarter.
Another aspect to this market that is not explained is that we are in transition from a bull market and a booming economy to a bear market and a depression. All the financial and governmental forces with all of their powers are at work to prevent its occurrence. Both Washington and Wall Street want to keep the sheep corralled in their pens. The problem is that the sheep are getting skittish. They know instinctively that something is wrong. They see the scandals. They see the fraud. They know that they have been lied to. They are looking for something to believe. Washington and Wall Street are losing their credibility with each new passing scandal and bankruptcy. The financial system is breaking down and the multiple bubbles created by the Fed are starting to deflate. The only bubble left is the housing market and even that is on a shaky foundation of debt.
Four Words Sum It All Up
So how do you explain what is now happening in the markets? It is very easy. It can be explained in four words: debt, deflation, transition, and things. The credit bubble can explain what you are now seeing in the financial markets along with the parade of bankruptcies that you see almost on a daily basis. Deflation is the consequence of that debt imploding. Transition explains where we are going. It explains the move in gold, oil, and commodity prices this year. Things best explain where that money is going once it exits the financial system. That is what has driven prices of raw materials and precious metal stocks this year. Please review the chart above of the HUI and the Dow and the Nasdaq over the last year. That is the story that the financial industry doesn't not want you to see or understand. Despite its performance over the last two years, the standard advice given is to sell what is going up and buy what has been going down. This is why Wall Street is losing its credibility. They are scared stiff that investors will bail out of their mutual funds and cross over the road to the other side. So they encourage investors to sell and buy stocks like they always have done. There is only one problem -- that advice has proven deadly to your financial health. Study the chart above and ask yourself what you see. Then make the decision as to which road you want to travel on.
The second phase of the bear market in equities has begun; while the first phase in a new bull market in metals is in a corrective phase. This corrective phase has been helped along by the financial industry, which is selling off shares after taking profits, and scared investors who have seen their accounts pull back over the last few weeks. The financial industry is hoping that the sheep stay in their financial corral and don't break lose for the other side. So they will do all that is possible to discredit this new bull market. Even after today, the HUI is up over 62% for the year in comparison to losses of 23% for the Dow, 31% for the S&P 500 and 37% for the Nasdaq. The HUI was up over 127% before pulling back. It is still up over 62%.
As mentioned earlier, gold and silver are emotional investments. They move on emotion, especially fear. There is no better barometer of fear in the financial markets than gold. This is why the financial industry doesn't want to see its rise. But bare in mind, this is a thin market. There are 1500-ton annual deficits in gold and 100 million ounce annual deficits in silver. The above-ground stockpiles of silver are dwindling; while gold is kept low by a constant supply of gold being sold into the markets by central banks and gold leasing. This game cannot last forever unless central bankers are prepared to tell the citizens of their country that there is nothing to back their national currency. Eventually, like the London Gold Pool of the 60's, this game will be abandoned as it is realized that it is hopeless to stop the transition from gold as a commodity to its historical role as money. That is exactly what it is doing now.
Look around and tell me what you see. The financial markets are imploding. Bankruptcies are becoming a weekly, if not daily occurrence, scandals and fraud are being exposed almost on a daily basis. What you are seeing is the evaporation of confidence in the financial system. What remaining confidence that is left will disappear when we get a string of bankruptcies in the financial system, especially in the banking sector. That is what is coming next. You can’thave all of these bad loans, leveraged derivative plays, and overextensions of credit, hidden loans, frauds and scandal without consequences. Look at the charts of all of the financial sector from the major banks, credit card companies, government sponsored entities, mortgage insurance companies, to regional banks. The financial system is headed for trouble. That is what the rise in gold is signaling.
This is not the time to hesitate or the time to be without firm convictions or beliefs. If you don't have them, get into cash and be content with what you have left. For those of you that believe what the rise in gold and fall in the financial markets are telling you, it is time to take advantage of those who are subsidizing the price of gold and silver. It is the time of mice and men. It is a time when those who have convictions must stand by their beliefs because those who have none will eventually follow.
European stocks fell after insurers Skandia AB and Fortis said lower share prices are hurting results. The Stoxx 50 fell 50.40, or 2 percent, to 2449.99. It's shed 12 percent since Thursday's close. Asian stocks rose, led by Hyundai Motor Co., Honda Motor Co. and other automakers as a rebound in the U.S. dollar led to expectations that their sales in the world's biggest car market will increase. South Korea's Kospi index rose 3.1 percent, while Japan's Nikkei 225 stock average added 0.3 percent.
Government bonds gained considerable ground for a second session as safe-haven seekers bid up the fixed-income sector. The 10-year Treasury note put on 20/32 to yield 4.53% while the 30-year government bond piled on 1 6/32 to yield 5.33%.
© 2002 James Puplava