Gold-Dow Jones comparison – More evidence of Gold rally/stock drop?

Gold prices spiked on Thursday on account of risk aversion in the global equity markets, blamed largely on China slowdown initially and now on the delay in the Fed rate hike (US no longer bright spot). Much has been said across the globe, whether the Fed shall raise rates or not and whether Gold will rally or whether stocks would rally or we are in for a major crash. 

A simple comparison of the Gold and Dow Jones Industrial Average (DJIA) chart add to the evidence that a major risk aversion in stocks and gold rally is due/or have already begun. 




The chart shows...

1. Gold started its rally from the low of USD 699.35 seen in Nov 2008 and rose to a record high of USD 1920.84 in September 2011. During the same period, the DJIA also rallied.
2. Since October 2011, gold prices have been on a downtrend and hit a low of USD 1073/Oz in July 2015. However, the DJIA continued to rally throughout the period of gold downtrend.
3. The decline in Gold has been relatively less steep – moving in falling channel – since last two years, even though stocks continued to rise till May 2015.

Why did Gold collapse in last four years?

From the chart, it is easy to blame the stock market rally – Risk-on hurts gold. However, the major reason behind the collapse was the absence of much anticipated hyperinflation. Since Q1 2009 stock markets began to rise and so did gold. 

Many in the market feared, the Fed’s unprecedented QE 1 and QE 2 program would lead to sharp rise in hyperinflation, represented by the CPI index. Consequently, gold prices rallied. Occasionally, the EUR crisis and US downgrade in 2011 also added to the rise in the metal. However, major role was played by expectations that QE could lead to a sudden spike in QE. 

And hyperinflation did occur, but in financial instruments - stocks. Consequently, the metal turned lower and has been in the downtrend for 4-years now. The QE taper and the rate hike talks since last one year also added to the bearish pressure. 

Major risk aversion in stocks ahead

The situation now is that neither of the major advanced economy has inflation (represented by CPI) even closer to 2% target, but the stock markets have been hyperinflated. Commodities prices are in the downtrend with no major catalyst seen ahead for a turn higher. Thus, we have deflation on cards and the disconnect between stock prices and commodities may be the highest in years or at record highs. Furthermore, we are moving towards a rate hike (rate hike may not happen at all), still we are unlikely to have a another QE at least in the short-term . Consequently, there is a high possibility that the disconnect between stocks and commodity prices erases. Given the slowdown in the global economy, commodity prices are unlikely to rally, thus, it is safer to assume that only stocks could head lower. 

Gold could rally

Though we are unlikely to have hyperinflation represented by the CPI, still, gold prices look set for a rally. Safe haven demand could come back strong as stocks continue to fall. Irrespective of whether Fed hikes rate or not, correction in the stocks could continue. Furthermore, low probability of more than one rate hike means Fed would be viewed as dovish and other major central banks are likely to retaliate, especially in Asia. Consequently, the metal could also find support from the rise in non-USD terms as well. 

A major stock market crash could add to deflation, still Gold could strengthen on hedging demand and currency debasement (rate cuts in Asia). 

Overall, the metal looks set for a rally. The immediate target is the falling channel resistance seen on the monthly chart above at USD 1270/Oz. A break above the same would open doors for USD 1430/Oz levels within a year. 

The view on gold is published here in detail