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GOLD MARKET FLASH NOTE

Monday, 1st May 2017

What's Not Up for Gold  

There is a push/pull in the gold market that is testing the patience of investors. It's time to stay calm, in our opinion.

Gold took a spin to the upside over the past two months as worries about war in the Middle East (cruise missile attacks on Syria and the Mother of All Bombs in Afghanistan) and war in the Korean peninsula (dispatched aircraft carriers and expectations of further nuclear tests) brought investors into gold. Unless geopolitical events have immediate economic or financial consequences, their impact on gold is minimal and brief. And so it was. Gold sentiment rose to YTD highs and broke above the 200 day moving average but the gold stocks tellingly underperformed gold. The COMEX COTs went from bullish to neutral as the Commercial net short position rose sharply. A correction was in the cards and here it is.

At the same time, the macro developments that will (eventually) drive the gold price higher have been slower to impact markets than we had thought. The debt ceiling is not yet top-of-mind due to the April 15-induced cash infusion and distractions such as Obamacare. Markets still seem to think that the Trump Presidency will produce aggressive tax cuts and infrastructure spending. Since last November, we have cautioned against such fantasies and we continue to believe that the stock market will break down once it is clear that these expectations will not be met.

U.S economic data is poor, as we expected, but the Fed seems keen to continue a policy of 'monetary normalization' because it can; the financial markets are extremely buoyant so if the Fed cannot tighten now, it never will. To preserve its battered credibility, we expect the Fed to raise rates again at its June FOMC meeting. That, too, is likely weighing on gold in the short term but the greater impact is going to be felt in the stock market, in our opinion.

In our view, this is the calm before the storm. Valuations in the stock market are insanely stretched; the price-to-sales ratio for the median stock is the highest ever. The market is priced for perfection. Volatility has never been more compressed. There are legions of risks that promise to interrupt the current complacency while markets look increasingly brittle.

Perhaps the greatest risk of all is simply exhaustion. Recently, we have seen the major indices open with small gaps above the previous day's close. Dr. John Hussman writes that when these gaps occur after an extended advance, they are called "exhaustion gaps" signalling desperate investors are chasing the prevailing trend for fear of missing out. For individual stocks, these gaps are sometimes just temporary areas of consolidation. For the overall market, however, "they tend to have far more hostile outcomes, particularly when they are associated with record highs, rich valuations, lopsided bullish sentiment and deterioration in the uniformity of market internals"(http://www.hussman.net/wmc/wmc170501.htm).

We believe that we may now be approaching a March 2000 moment when the stock market finally enters the bear phase of a complete market cycle and gold begins its next leg up.