1. Dow 200-point Decline only a “Blip”? We noted in our mid-week audio commentary the importance of the gold price holding above $1670-80. On a correction of this sort, we rarely see the recent lows ($1532) challenged, and any new lows are typically higher than the previous ones by a significant amount. Had $1670 been violated, the logical destination would be in the $1590 range, well above the $1532 levels of December.
We are finding volumes a bit light, but the price action has nonetheless been strong. Friday’s retest of and subsequent recovery from the weekly lows reaffirms a reasonably strong market. A close above $1700.00 was constructive. Sideways consolidation should be expected, with new highs (above $1920) unlikely till the fourth quarter of 2012 or first quarter of 2013. Take advantage of any and all weakness by making acquisitions on the dips.
Silver continues to remain attractive at a 50-60:1 ratio to gold (and in a price range of $29-34 an ounce). We expect more interim swoons from silver, but it should outperform gold as we move into the next leg higher in price. If you are inclined to hedge systemic risks with a less market-correlated asset, you still might prefer gold. The only difference in emphasis is growth versus a more conservative focus on asset preservation, gold remaining the standout in the latter case.
Equity markets moved lower this week after failing to break decisively above 13,000 on the Dow, 3,000 on Nasdaq, and 1,370 on the S&P. However, they have already retested the upper boundaries in a snap-back rally. Will the previous highs remain a cap on the market? We suspect they will. Global markets continue to move in tandem with news headlines.
The odds favor a potentially severe correction because, in spite of improved economic statistics, no new Fed money (QE) has come into the equities market. Instead, we believe stocks have been the benefactors of accelerating “carry-trade” dynamics. Said another way, with confidence levels high, the incremental acquisition of leverage (debt) has propelled markets higher, subsequently increasing risk. So the situation remains a trader’s haven and an investor’s nightmare.
Last week’s NYSE volume was the weakest of the year (Friday being particularly awful), and insiders continue to sell at an aggressive pace. Price improvements are highly dependent on central bank liquidity promises or the market’s expectation that liquidity will be provided. However, not only has the Fed signaled a reluctance to accommodate further (QE3 remains on hold), but the last three Fed disclosures have indicated a reduction in its balance sheet by as much as 43 billion in the last week. Having said that, prices already reflect the assumption of more liquidity coming. So what takes things higher from here? Delivery of same? No, a new catalyst is needed.
2. Laws Are for Losers: A final note on European stability and the Greek bond swap: The ECB move in December and again this last month to refinance over $1.3 trillion in outstanding bonds was critical for current stability in the eurozone. As we’ve noted many times in the past, rollover risk was and is the primary concern of debt-laden and debt-dependent sovereigns. The market showed no interest in rolling over the debts coming due in 2012-2015. In consequence, the ECB smoothed things over by replacing the market’s natural pricing structure (higher interest rates for increased risk) with synthetic demand for bonds via its various asset purchase schemes, and of course the LTRO as well. That makes two western central banks, the Fed and the ECB, which have made a full commitment to price stability via market intervention. All told, central bank balance sheets in the last three years have grown to over $8 trillion.
The collective actions clauses, which forced the minority of bond holders to participate on the basis of majority voluntary participation, will likely trigger several billion dollars in insurance payouts to the holders of default insurance (CDS instruments). More than anything, this episode has eroded the confidence with which investors can approach the markets. Previously, they assumed the sanctity of contracts and the rule of law. What market participants will now live with is the awareness that, regardless of how well the rules of the game are codified, the rules can still be changed in the middle of play. It appears that we are witnessing an extension of the winter season within the capital markets, without any natural move towards spring.
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