Affect on gold stocks of a severe decline in the general stockmarket
One of the most important questions facing investors in precious metals stocks is that of what would happen to them in the event of an all-out crash or, at least, a severe decline in the broad market. This question is of course very topical following the sudden sharp decline in the general stockmarkets over the past couple of days.
This article is an attempt to answer that question and to highlight what I believe to be the most likely scenario and the most effective way for PM share investors to deal with it.
An important point that should be borne in mind is that, although what we are talking about here is a potential panic scenario in the general market, it does not mean that WE have to panic. This article, although prompted by the broad market action during last week, is not a knee-jerk response to it, as I have throughout been aware of the continually growing probability of the over-extended bear market rally coming abruptly to an end.
Another important point to grasp is that although Thursday's general market plunge was clearly, in part at least, a knee-jerk reaction to the horrific events in Madrid, and we may therefore see a rebound in coming days/weeks, it was also a manifestation of the internal rot that has been festering away in the market for a long time, exemplified by heavy insider selling. It is important, therefore, not to be fooled should the market steady and try to struggle higher again even if it succeeds in limping along for another few months.
The bear market rally in the general market and Tech stocks, that I have dubbed "Son of Bubble," which started a year ago certainly looks impressive and has in some quarters been hailed as a new bull market, which it is not, although that conveniently depends on how you define a bull market. It rather takes the shine off it when you view it measured against other currencies, i.e. taking into account the fall in the dollar, when you do that you realize that in real value terms, you are looking only at an anaemic bear market rally that has come nowhere near the 2000 highs.
As the rally proceeded many
advisors who realized that it was a bear market rally fell silent,
myself included. There's simply no point in 'crying wolf' continually
and ending up looking like an idiot. I have contented myself
with observing it with ghoulish fascination, watching for the
first cracks to appear, and they certainly have over the past
few days. I reasoned a long time ago that it would top out on
the Dow at around 10,200, due to the weight of overhead resistance,
but due to the quantity of speculative money at large in the
system, it has made it as high as 10,700. Despite the fall in
the dollar, chart resistance levels are still operative due to
the fact that many investors within the US have not factored
in the real value losses resulting from a weakened currency.
The name of the game now is
to keep the merry-go-round going for as long as possible - at
least until the election. It is widely known amongst politicians
that severe recession accompanied by high unemployment does not
go down too well with voters, so if you have the opportunity
as a politician to avoid that, by whatever means, you take it.
After all, the average voter doesn't usually think about anything
very much, and a runaway deficit is an abstract and distant problem
that is much less of a concern than whether they have a job and
money in their pocket. In this situation an obliging Federal
Reserve that is prepared to ramp the money supply and gush liquidity
into the system is the answer to a politician's prayer. The resulting
problems of hyperinflation followed by deflationary collapse
that may be result after the election are a minor nuisance that
can be dealt with later.
If you live in the US and you
don't believe me then ask yourself why your children face growing
up consuming GM foods and drinks containing aspartame, why your
national parks are being opened up for logging and mining and
why, with millions living in conditions of poverty, the defense
budget is being hugely increased and so on. The public, of course,
will believe anything, as long as it's presented to them in the
right way by a compliant syndicated media. Hence the grossly
distorted figures for inflation and unemployment, which have
been massaged downwards. There is a tremendous incentive for
reducing the inflation figures because it means that you can
dodge paying cost of living increases to the unfortunates on
In considering this I must
emphasize to readers that we have never been in a situation quite
like this before, so it is best to put ourselves in a position
where we are able to be flexible and include the worst-case scenario
in our planning. When the storm breaks and interest rates go
up, it is reasonable to expect stockmarkets to plunge - in fact
as the markets will anticipate these rate rises we can expect
this to happen BEFORE the rate rises take effect, we could possibly
be seeing the first signs of it now. At this time I would expect
gold to go up, but perhaps not by much initially. Now here is
the point; at a time like this the precious metals stocks could
get caught up briefly in the general melee, with across the board
general selling, as investors try to safeguard everything they
can and also use the sale of stocks which are at better prices
to average up their losing positions. The result of this may
be what I would call an "icicle" formation on the charts
in many PM stocks - a vicious plunge followed by a strong rally.
My view is that as the crisis deepens gold (and silver) will
forge ahead and the PM stocks, after swiftly recovering from
a possible plunge in sympathy with the general market during
its crash or steep decline phase, will then move ahead in strong
uptrends. This view is somewhere between that held by Prechter
who believes that gold and silver will fall and the PM stocks
will get dragged down with the general market, and Jim Sinclair,
who is all-out raging bullish.
Finally I have to say that
I really do not know if the PM stocks will break down below these
important support levels in the event of a severe general market
decline, but at least, these levels give us some kind of defensive
line in the sand. It is entirely possible that the general market
will recover from here and limp along for a few months more before
a plunge begins, and in the meantime a new intermediate uptrend
in gold stocks could start, in which case we will have to raise
our defensive stops.
website at clivemaund.com.