Insights & Advice

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Gold Takes Center Stage as Markets Waffle

September arrived and stocks dropped on cue right out of the box with the S&P 500 breaking the 1,000 level on Monday. For four days in a row, the indexes moved lower before once again turning higher on Thursday and Friday. It was as if all the hype about how bad the months of September and October usually are was a self-fulfilling prophecy. The problem for me is that corrections don’t usually occur when everyone in the world is expecting them.

Clearly we had some encouraging economic news this week with 30 year, fixed mortgage rates falling to 5.08%, unemployment numbers , although still rising, were less than expected, the service sector improved and August retail sales numbers were mixed. That was good news since investors feared a rout in the back-to-school sales this year.

Yet, this improving picture did little to boost investor sentiment. Nor should it, say the bears, since much of this news has already been discounted by the markets. In order to move the markets higher, they say, something unexpected must occur. Although, I suspect the markets will continue to climb despite this bearish sentiment.

This week, however, it was gold that took center stage. Ever since reaching a high of $1003 back in early March of 2008, gold has been in a trading range mirroring the U.S. dollar. As the dollar declined, bullion moved higher and vice versa. Gold has always been considered a viable alternative to the world’s paper currencies, especially in times of uncertainty. Recently that inverse relationship with the greenback appears to be wavering. This has both confused and confounded investors who have no use for gold on a fundamental basis.

On the other hand, technical analysts are excited by the recent action as gold came within fifty cents of breaking $1,000 this week before pulling back a bit on Friday. If it hits $1,000 it will be the third time gold has hit this magic number. This, according to analysts, would be an extremely positive development and would convince many traders that we would be on the verge of a new bull run for the metal.

John Roque, an old friend and a well-known technical analyst at WJB Capital Group, Inc. in Manhattan, has created a relative ratio of gold to the S&P 500 stock index from December 1928 to the present. John breaks that time period down into four cycles. In the period between the late 1920s through the early 1940s (cycle 1) gold reached a peak of 4.5 times the S&P 500. During cycle 2, in the early 1970s, gold declined to 2.7 times the S&P. In Cycle 3, around January 1980, gold peaked at nearly 6 times the S&P. So far in this, the fourth cycle, this ratio has only been as high as 1.4 times which is slightly below the long term average of 1.5 times the price of the S&P.

Now, that does not mean that gold necessarily will peak at 4-5 or even 6 times the S&P but it is reasonable to expect gold prices to at least reach or even move somewhat higher than the average. That could translate to a price of around $1,150/OZ. or better. I recall many analysts, who could be called “gold bugs”, have predicted that once gold breaches the $1,000 mark for a third time it will not go below that level in our lifetime. That of course remains to be seen. Traders who buy and sell commodities, unlike stocks or bonds, are largely guided by technical price levels. Gold, for example, can be less than ten cents away from a new price level (say, $1,000/OZ.) but until it actually breaks that level, traders will only give you even odds that it will.

For those readers who want to play gold, I suggest you buy a mutual fund or exchange traded fund that invests in several commodities—basic metals, precious metals, maybe agriculture and oil—so that you spread the risk. Commodities are speculative and not for the faint of heart. On its own, gold can easily move up or down as much as $30/OZ whipsawing unwary investors. So if you can’t stand that kind of heat, stay out of that particular kitchen and instead use my diversification suggestion. Otherwise, good hunting and let me know how you do.

Posted in A Few Dollars More, At the Market