Effects of a Bond Market Plunge
There are many conflicting forces at work in the gold and gold share market right now, added to which we have seen an increasing polarisation amongst prominent market commentators over the past week or two, with some remaining outright bullish and others turning bearish. In the face of all this the safest and most effective approach to this market is one of pragmatism, i.e. strategies based on a cool appraisal of the possible scenarios going forward, which are not hostage to any dogma or preconceived ideas.
For many, many months we have
observed, and gone along with, the major bear market rally in
the general stockmarket, aware that it has been fuelled by an
unsustainable combination of zero real interest rates, a massive
injection of liquidity and the unbridled expansion of credit
and debt, the purpose seemingly being to stoke up a "Teflon
recovery" and a feel good factor, so that the current US
administration gets re-elected. It is a combination of circumstances
that cannot continue - and will not continue.
Rising rates are the "Kiss of Death" for the stockmarket, and the moment rates start rising we can expect to witness a severe decline in the general stockmarket. This is partly because the first rate rise, however modest, will be the equivalent of draping the New York stock exchange with a 50-foot high banner saying "Take Profits!" - whatever they say no-one will believe that the rise is anything other than the first of many. To be realistic, US investors should also factor in the ravaging effects of the falling dollar on their capital. Even though the US is a huge country, almost a continent and it is therefore easy to adopt an insular, inward looking attitude and ignore the effects of the falling dollar, it should still be acknowledged for what it is, a real loss of international purchasing power. It is for this reason that I have also included a long-term chart showing the Dow Jones index expressed in Euros above.
On Friday the 2nd the bond
market plunged amid a wave of selling, resulting in the biggest
one-day loss for years. Such a move at this juncture, although
only a one-day occurrence, signals the probable start of the
long-awaited stampede out of bonds. Bonds down equals interest
rates up. Real interest rates are already rising and it is now
only a matter of time, probably no more than a few months, before
the Fed's hand is forced and "official" interest rates
have to rise. The impact of rate rises on a chronically debt-ridden
and maladjusted economy cannot be over-estimated. When this happens
the stockmarket can be expected to nosedive.
Fundamentally it might
make no sense, but it is a dangerous mistake to underestimate
the destructive power of a mob on the move. We will know if this
is happening if the important support levels shown on the charts
below are breached around the time of the onset of a general
market meltdown. If they are it will indicate a serious technical
weakening and open the door to the possibility of steep declines.
There is, however, one factor that could save the PM stocks and
even cause them to rise when the general stockmarket caves in,
and that is if there is a SIMULTANEOUS flight of capital into
the precious metals, causing an immediate dramatic advance by
both gold and silver. Treading water won't be good enough. In
my view, if the metals only succeed in holding steady, the stocks
will get taken down. The second potential negative effect of
these developments, in particular the rising rates, will result
from any support given to the dollar by these rising rates, although
this is more difficult to quantify. The dollar has been strengthening
in recent weeks, and this looks like it may have been in anticipation
of rising rates. To the extent that the dollar rises, it will
probably have an adverse effect on gold, which appears to have
just double-topped in the $430 area, and is currently therefore
in a trading range above $390.
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