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Golden canary

15 April 2013 By Ian Campbell

Gold is a canary in the mine for financial markets. Its burst bubble warns of the huge dangers lurking for bonds, commodities and stocks. Those dangers may be at a safe distance now, but they are real.

The correction in gold is an extreme case. The metal had everything in its favour for a decade. Goldbugs wisely distrusted the U.S. housing bubble. When it popped, quantitative easing debased the dollar and ultra-low interest rates reduced the opportunity cost of holding gold. A U.S. recovery, however weak, and a rising dollar were the writing on the wall. The smart money has already been heading out. The tipping point had to come, and has.

In markets other than gold and silver the danger of large corrections is there – but the tipping point isn’t here yet. Fears about U.S. and global growth, and the risk of earnings shocks, are the issues for stocks and commodities. China’s GDP growth slowed to 7.7 percent in the first quarter. The most recent U.S. retail sales and jobs data have disappointed.

These growth fears are not bad enough to cause panic talk of enhanced bond buying by the U.S. Federal Reserve, expectations that would support riskier assets. They merely sustain the hope that easing won’t taper off quickly. Yet U.S. stocks are at all-time highs and the Vix options volatility index trades close to its lowest since 2007. That complacency need be rattled only a little for stocks to beat a retreat.

Rising U.S. Treasuries betray an expectation of no change on quantitative easing soon. The yield on the 10-year note is down from over 2 percent in March to 1.72 percent. Japan’s easing may also be supportive of Treasuries. With money-printing and low growth still on their side, safe-haven bonds remain safe.

The big problem for markets will come when growth fears recede and extreme U.S. monetary policy begins to end. Falls in stocks and commodities could be substantial, but also possibly mitigated to some extent by stronger economic fundamentals. Bonds are still more vulnerable. Like gold, they are a safe haven past their time.

Gold’s lesson for investors is one most know already. Markets are being dangerously distorted by easy money. Corrections will come – and be severe when they do.


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