Gold sell-off to come with a stock market correction
Posted on 05 August 2010 with 2 comments from readers
Gold bugs will howl. But it is obvious enough that any major stock market correction – which must be looming on the horizon given this incredibly overbought rally now trading on very thin volumes – will bring gold prices tumbling down as in late 2008.
Is it really any different this time? Well, sadly not, except that the world’s central banks have expended most of their arsenal of weapons. Cutting interest rates is not possible with near zero rates now in place.
Margin calls
So what happens is that stocks sell-off and margin calls are made to investors. They then have to sell something else to pay up. That could be gold, commodities or just about anything.
At the same time the dollar will automatically rally, along with treasuries as markets are liquidated for cash. This increases the demand for dollars and pushes up its value. A rising dollar and falling gold price are a normal correlation, though this does not always apply.
However, gold will not necessarily tumble below $700 as in the spring of 2009. The support level this time is surely around the magic $1,000 mark, and there will be many investors happy to buy into the yellow metal at this kind of discount.
If the 2008-9 sell-off in gold is a guide then the price will bottom out with the stock market. How long will that take? The end of October is one very reasonable estimate. Market falls are generally faster than market rises, and October is traditionally a bad month for stocks.
Continous rally?
Can we be certain about this? No but you have to consider how likely is the alternative of a continuous stock market rally into the future accompanied by a faltering US recovery?
The unemployment data tomorrow is surely the thing to watch out for. Astrologer Arch Crawford is pretty good at timing his predictions to coincide with major data series as well as planetary movements, and that would be a good reason for anybody to wonder about a crash tomorrow.
But gold will not emerge unscathed when and not if the markets correct. It will, however, be correct to view this as a buying opportunity as the stimulus measures that follow will ultimately be extremely positive for the yellow metal.
2 Comments posted by readers:
Initial weekly USA jobless claims ROSE 19,000 to 479,000. Economists had forecast a decline to 460,000. CNBC TV is trying to spin it into good news with ’seasonal adjustments’ talk. Sure.
The US Congress voted to give the States another big chunk of borrowed money, $26,000,000,000, if I recall correctly, to prevent massive layoffs of State and city employees.
Mohamed El-Erian of PIMCO said that there is now a 20% chance of a double dip.
I never thought that I would live to hear the word deflation used so much. Normally, that would be bad for the gold price. But with gold, many other factors now come into play. China and India are developing a middle class which could increase the demand for gold a lot faster than it can be produced. That could keep the price constant, or rising, even in a slow growth period in the developed world. A major war could start in the MEPS region, or between India and Pakistan. That might send gold way up in a panic.
Deflation could actually set in. I suppose that would send the gold price down quite a bit. But who knows? It could stay right where it is, or even go up, as the US Fed created more dollars. I think that the US Government will go to extremes in order to prevent deflation from taking hold in the USA.
I guess all that stuff is why the experts say never put ALL of your money into gold, or bonds, or real estate, or stocks or tulips.
@Bill: Good commentary, as usual.
For All:
Whenever the public reads about deflation, they are often “told” that it is a curse; this may be true for corrupt governments whose economies have been totally wrecked. For the economies of other countries, however, some deflationary periods are part of the grand economic cycle.
Enter the Dragon: Central Banks
For a long time now, I’ve believed that western central banks have two arch-enemies, namely deflation and gold; and it seems that the greater the corruption within a government, the more their central banks abhor these enemies (I guess I should add a third arch-enemy, namely hyper-inflation, which is the byproduct of highly corrupt governments). Deflation is their enemy because it thwarts their goal to maintain a 2% to 3% inflation rate (and they do this in order to provide ever increasing liquidity, thereby enabling banks to profit enormously). Gold is their enemy because it exposes the truth regarding a government’s debasement of their own currency through deficit spending.
Alan Greenspan said it best in 1966, in his now famous essay entitled “Gold and Economic Freedom” (he wrote this essay for Ayn Rand in her 1966 book on Capitalism). In it, h said: “Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” Wow!
Recommended Reading:
1. Greenspan’s Essay: http://www.financialsense.com/metals/greenspan1966.html
The words in Greenspan’s essay, which is only 2 pages long, become more hallowed with time. I find it absolutely fascinating that, a few years ago, Greenspan is quoted as telling US Congressman Ron Paul that “he would never change a word of his Gold and Economic Freedom essay.” Wow again!
2. Peter Warburton’s Essay in 2001: http://www.gold-eagle.com/gold_digest_01/warburton041801.html
Warburton’s essay is rather long, but well worth the time. This essay, too, is becoming more hallowed with time.