Equity Sell-Off And the Price of Gold

Special Edition of The Market Gage - the precious metals market newsletter

Here’s why the equity market sell-off will not help the price of Gold in the short term, but will in the long term.

If you remember just a few months ago, I indicated that a corporate tax cut was totally unnecessary by citing strong corporate earnings, low interest rates and the fact that all the tax cuts would do was give Wall Street executives bigger bonuses. I predicted that this would also heat up the economy, increase the country’s debt and raise interest rates.

We are now seeing the results of such actions. Watch what happens went individual debt increases, as it has over the past few years. With all the excitement in the equity markets, wage growth and strong job numbers,
individuals have increased their household debt (now at historic highs) without considering the fact that low interest rates will not be around forever.

So one can only imagine what will happen with the proposed interest rate hikes this year that the Fed has to impose to tame an overheated economy. With higher interest rates, U.S. Household debt should increase substantially. Not to mention an increase in banks’ non-performing loans and an increase in our country’s debt.

With all the news in the equity markets, I haven’t heard much talk about another potential Government shut down coming this week. And with all these memos, first the Republican one and now the Democrat’s version; how in the world can anyone expect these folks on Capitol Hill will come to any agreement?

Back to Our Markets

So what was the spark that caused the equity sell off? Two reasons. First, one must remember the equity market grew by seven percent just in the month of January. Everyone knows that type of growth is unsustainable. Add it up and the stock market would gain 90 percent in just one year. So a correction was in the cards. Second, and most important, was the story that came out from the Atlanta Fed predicting the first quarter annualized GDP growth to be 5.4 percent. At that point, the whole world knew that the Fed would have to be more aggressive in raising rates at a faster clip.

Everyone knows the market for the longest time loved cheap money and now the party is over and the equity market reacted accordingly.

As always, you need to watch the activity in the CBOE VIX Volatility Index, also known as the “fear index.” Yesterday, the VIX Index was up over 100 percent. During that rise yesterday, algorithm programs kicked in and created significant volatility when the Dow Industrial average, at one point, moved 500 points in five minutes. I expect that index to soften up quite a bit today.

So what does this all mean? As a gold trader and investor I’m always concerned with higher interest rates. You can say that lower corporate tax rates are a good thing, making us more competitive on the world stage. But by implementing this strategy, you can create an overheated economy and you run the risk of having to raise rates to stop it in its tracks.

So in the short term, we can expect higher interest rates, but after the selloff in the equity markets not at a faster pace that most traders feared if we had an overheated economy.

But what this sell off does, as indicated by the CME FED Watch tool indicator (as the odds of a more aggressive rate hike program has softened in the last two days), is make the Fed really read all the tea leaves and declare once again any future rate hikes will be data dependent.

Going forward, the price of Gold should benefit from a less aggressive Fed policy, but in the meantime we need to see some clarity on where our economy is heading and what the result on future rate hikes will be.

As I shared my opinion with a fellow Gold trader this morning, he said, “it sounds like a cost averaging Gold buying strategy might be a good idea.”

I expect the equity markers will calm down significantly today and everything will come back in line.

In the meantime, I will (and you should too) watch the CBOE VIX Index for a good indication of what the street is thinking.

Have a wonderful Tuesday.

Disclaimer: This editorial has been prepared by Walter Pehowich of Dillon Gage Metals for information and thought-provoking purposes only and does not purport to predict or forecast actual results. This editorial opinion is not to be construed as investment advice or as a recommendation regarding any particular security, commodity or course of action. Opinions expressed herein cannot be attributable to Dillon Gage. Reasonable people may disagree about the events discussed or opinions expressed herein. In the event any of the assumptions used herein do not come to fruition, results are likely to vary substantially. It is not a solicitation or advice to make any exchange in commodities, securities or other financial instruments. No part of this editorial may be reproduced in any manner, in whole or in part, without the prior written permission of Dillon Gage Metals. Dillon Gage Metals shall not have any liability for any damages of any kind whatsoever relating to this editorial. You should consult your advisers with respect to these areas. By posting this editorial, you acknowledge, understand and accept this disclaimer.