Sunday, 14 February 2016

Why Gold Shines When Stock Market Declines?

I thought it's time to write one of those article that gives an overview or the overall tone of the markets early in the year as I had done so last year. If I sounded negative last year, I'm much more so this year.

 Parallel Falls in Gold and Stock Markets 
A friend asked me that during the decline of the 2008 stock markets, the gold market got pulled down with it, dropping from $1073 to $798 (a drop of 26%), as seen from the charts below.

Gold price chart, between 2000 and 2010
(Click to enlarge)

Since the gold drop in 2008, there's a myth created that was repeated almost like a mantra, "The stock bear market plunge will pull the gold market along with it."

I would like to debunk that myth. In fact, I like to show that stock market plunges would be beneficial to gold price rises. So how do I reconcile the parallel falls in both stock and gold markets that occurred in 2008?

I thought the answer is quite obvious, and it's right there in the charts.

Let's look at these charts for both markets in the period between 2001 and 2010.

Dow Jones Industrial Average chart, between 2000 and 2010
(Click to enlarge)

The equity market, as measured by DJIA (Dow Jones Industrial Average), started its bull market since 2002 before its demise in late 2007.

The gold market, on the other hand, had started its bull market earlier on April 2001. So by Mar 2008 when the gold started to correct, it had a bull run of practically 7 years.

Let's put the stats into a table below for easy comparisons.

Gold DJIA
 Length of bull markets (months)  85  61
 Bull run growth  208%  59%
 Length of correction (months) 7  16
 Market correction25.6% 50%


From the table, one can see that the gold bull run went up by a staggering of 208.3% and yet corrected by only 25.6%. On the other hand, DJIA bull run increased by 59%, and corrected a whopping 50%.

To put it simply, the size of gold drop during 2008 should be described as a small correction while the size of DJIA drop should be described as a crash.

With such a stunning bull run, the gold price correction not only should be expected, but a healthy price action.


 Diametrically Opposed Moves in Gold and Stock Markets 
This time, the gold and stock markets run up towards 2016 are very different. In fact, they're opposite.

Gold price chart, between 2010 and 2016

Dow Jones Industrial Average chart, between 2010 and 2016


Once, again, let's put the stats into a table below for easy comparisons.

Gold DJIA
 Length of bull markets (months)  50  72
 Bull run growth  -41%  132%

Things are quite different between run-ups for the gold and stock markets this time around.

While DJIA had a staggering 132% bull market from 2009 to 2016, gold was in a bear market since 2011 with a correction of 41%.

I had been trying to work out when is this gold bear market going to end. I tried to calculate the turn-around point by technical analysis. But the hindsight is so clear now. The gold bull market starts when the bear stock market begins. This is what is occurring right now.

The bearish signal for SPX and bullish signal for gold both simultaneous flashing this week (week ending 13 Feb 2016).

spot gold price chart, between 2014 and 2016
Spot gold price above 1190 is bullish for gold market.
1190 is an intersection of 2 important price points as indicated in the chart.
(click to enlarge)

S&P500 chart, between 2015 and 2016
S&P500 below 1860 is bearish for equity market

While SPX has not been broken down below 1860 convincingly, but the case for bullish gold has far more conviction.

If you look at the following chart that covers more than a century of data for gold to S&P500 ratio, it's highly cyclical. We're much closer to the bottom than the chart suggests because the chart is in log scale. This indicates we're a long way from the top. If history is a guide, it implies that either the S&P has a long way to fall or gold has a long way to rise, or more likely, both.

Gold to S&P500 ratio, 100 years chart
(Click to enlarge)


 Fundamentally Speaking 
Now that we looked at the 2 market from a technical point of view. Let's look at these 2 markets from a macroeconomic analysis.

During the bull markets of 2000s, the world economies were booming, and yet the stock market - as measured by DJIA - went up only 59%. In this last bull market (and some would still call it THIS bull market) between 2009 and 2016, the market went up an incredible 132% even though the world economies were in the doldrums. This bull run is fueled by financial engineering like share buy-backs, acquisition, etc, which were all supported by the Fed's tidal waves of liquidity.

Gold had been corrected nicely in the last 5 years while this unsustainable stock market bull run kept up its irrational exuberance. This crazy run has to end. Reversion to mean suggests that these 2 markets should now swap bear and bull places.

Another indication that the market rotation has begun is that during this negative week, defensive stocks had enjoyed good rises.


 The Mother of All Bubble 
During any bear market, money flows out of risky, growth or momentum stocks and into defensive stocks and gold. Most of all, it hides in the safety of bond market. So let's look at the bond market.

Bond market is roughly twice as big as stock market, therefore the movement towards it will have large (negative) impact on stock market, which in turn has even larger (positive) impact on gold market.

10 year U.S. treasury note yield curve chart, starting 1981
A 35 year bull run in the bond market, creating the mother of all bubble.
10 year T-Note yield under 1.9% is a bullish signal for gold

The bond market has the longest bull run, and it's probably in a bigger bubble than the equity market. The 10 year T-Note is at 1.75%, which is considerably lower than in 2008. In other words, it's less attractive for the money to flow into bond now than it was in 2008. Since bond market is so many times larger than the gold market, even a trickle of stock market's outflows (hedge funds in particular) that's destined for bond market, if detoured into gold market, can cause a large spike in gold price.

With declining yield, holding onto government bonds resulting in poor returns to loosing money because of negative REAL interest rates. Gold really is the only market (along with commodities market) that had been in the cyclical bear market in the last 5+ years, while bond market was on a 35 year and stock market on the 7 year respective bubble bull run. If the bond bubble bursts, then gold will surely shoot to the moon. Of course, the bond market collapse may also lead to the the collapse of US currency reserve status. But that's a doomsday scenario. I'm NOT suggesting that will happen any time soon.

It seems gold is probably the only place for wealth protection. 10 year treasury yield below 1.9% is another bullish signal for gold market. Garry Shilling has a call of 1% yield on the 10 Year T-Note. If his call is turned out to be right (or even half right), this is very bullish for gold.

The chart below shows that US has never had such low real yield then it is now.

US long-term real yields since 1919


Speaking of bond market, the Junk Bond market is already collapsing. Of course, I'm not suggesting that the government bond market will follow suite. Just another indicator that there's something rotten in Denmark (ok, U.S and worldwide economies) since 2015, and yet many still hanging on the idea that things aren't looking as bad as they do, thanks to the mainstream media.

This popping of the junk bond market is due to the troubled oil frackers because of falling oil prices to level below their profitability. As their debt defaults rise, it results in the junk bond market collapse. Our economy is so intricately linked that a little fire starts in one place will spread to more places. Isn't the Greek problem the symptom of this? Why else a small economy like Greece perturbs the world so much?

JNK SPDR, Barclays High yield Bond ETF chart
Junk bond market is in bear territory since early last year.
(click to enlarge)


 Rotten From the Inside 
Of course, the U.S. stock market had been correcting in most of 2015. But a narrow group of heavy weighted stocks kept the major market indices up, and made it looks much better than it actually is. The Fed and the PPT (Plunge Protection Team, especially on Aug 2015) would want it that way. It's like a patient with early stage of cancer that looks okay on the outside. You need to look at the internals to find out the rot. Part of this narrow group of stocks that held up the market last year includes the market darlings of the FANG stocks (Facebook, Amazon, Netflix, and Google). Even the seemingly gravity-defying FANG are breaking down lately. There's fewer and fewer stocks hold up the market indices. The cancer is spreading.

What about the good old time-tested Dow Jones Theory that says a growing economy (aka bull market) must accompany a bullish transportation index because if the economy is growing, more goods would be shipped, leading to a bullish transport sector? Have we forgotten this simple reliable index since 1920s already?

This is one of key internal we should look at. The Dow Jones Transportation Average Index indicates that the economy has been contracting since the start of 2015 (not 2016). It had dropped some 30%, and its bearish trend is still firmly in place (meaning there's no evidence of a recovery just yet).

This transportation index should still be valid in the 21st century because even if we order stuff online, it will be delivered in the old fashioned way. We haven't yet able to fax materials over wires (at the moment, we can only teleport one single photo, not an entire PC).

Dow Jones Transportation Average Index chart
Bearish Transportation Average Index chart since the start of 2015


While last week flashed a few important market signals. The velocity of these 2 market developments is actually faster than I anticipated. It won't take long to confirm if the U.S. stock market is in the start of a bear market while gold is in the start of its bull market in 2016, the Year of the Fire Monkey.

Of course, a brief bear rally in stock market and a small retracement in gold prices in near term would be expected. 1st resistance for SPX is 1950, if that is cleared, the next resistance is 2020. If SPX clears that, all bets are off !


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