Only The Second Sell Off Of The Year

The US economy is in its 11th quarter of “recovery”; and by all standards, this “recovery” is sub-par.  The reason the economy is in this recovery—rather than 11+ quarters of decline—is due of the combination of 2 factors: ultra-low interest rates and a federal reserve that is monetizing US debt.  In the short term, there are very few consequences to monetizing the debt, specifically because the US Dollar is world’s reserve currency.  Long-term consequences are another story.

From this perspective, there are four catalysts for the price of gold:  the actual short-term and long-term consequences as well as the current perceptions of each.  The Federal Reserve has committed to an accommodative monetary policy for a long time; I suspect it will be longer than most people think, but that is irrelevant to this discussion.

The actual consequences of low interest rates and a devaluation of the dollar are supportive of the price of gold in both the short-term and long-term—although for different reasons.  In the short-term, a devaluation of the US Dollar via monetary policy is a natural positive catalyst.  In the long-term, ineffective US fiscal policy and a realignment of global currencies (a.k.a. “The Currency Wars”) is also a strong case for a higher price in gold.

Evaluating the perceived consequences is a more difficult task; and I think this is where the recent weakness has come from.  I would list the negatives as follows:

  • A move higher in the SPX
  • A general complacency in equities as represented by the VIX
  • The regime change in Japan
  • Euro-area comments regarding currency devaluation

My view:  volatility will gradually pick up as uncertainty comes back into play as the intermittently transient Euro-Zone and US fiscal problems are once again in the purview of investors.  I’ve previously noted SPX price studies that suggest a slightly bullish movement to the SPX—to the tune of 1% to 2%.  Well, that was when the SPX was around 1515 and it just may have put that +1% move higher to 1530 on Tuesday.  The upside is limited in equities and they have become much riskier as time passes without a more significant sell off.  It is too early to tell whether February 20th will mark the beginning of the correction in equities, but the smart strategy is to continue to reduce long equity exposure.

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