Stocks Selloff Boosting Gold / Commodities / Gold and Silver 2018

The recent stock-marketselloff is persisting, fueling mounting worries among investors.  The intensifying volatility and lack of aquick rebound higher is strangling euphoric sentiment, spawningself-reinforcing selling pressure.  Scoffedat a few months ago, the notions that a young bear market is underway and arecession looms are gaining traction. The great beneficiary of this ominous stock-market downturn will begold.

Gold has always been anessential asset class for prudently diversifying investment portfolios.  Uniquely it tends to rally when stock marketsweaken, offsetting some of the losses in typical stock-heavy portfolios.  Gold acts like portfolio insurance, usuallysoaring when stock markets plunge on unforeseen news.  All throughout history, wise investors haverecommended everyone have 5% to 10%of their portfolios in gold.

But like insurance ingeneral, the important role gold plays in portfolios is gradually forgottenwhen it isn’t needed.  Just a few months ago,the US stock markets seemed invincible. The flagship S&P 500 broad-market stock index (SPX) had powered333.2% higher over 9.5 years by late September. That made for the 2nd-largest and 1st-longest stock bull in US history!  Investors were convinced that would lastindefinitely.

The SPX had surged 9.6%year-to-date by that latest peak, while gold had slumped 7.3%.  Thus investors felt no need to allocatevirtually any capital to gold, they were and are radically underinvested init.  This is especially true of Americanstock investors, who were wildly optimistic after long years of bigstock-market gains.  Their effective portfolioexposure to gold was vanishingly small back in late September.

The 500 elite stocks ofthe SPX had an extreme collective market capitalization way up at $26,141.4b asthat topping month waned.  It isinteresting contrasting that with the physical gold bullion holdings of the world’sdominant gold exchange-traded fund, the American GLD SPDR Gold Shares.  GLD has long been the go-to destination forAmerican stock investors looking to allocate capital for gold exposure in theirportfolios.

At the end of Septemberas stock euphoria peaked, GLD’s total holdings were merely worth $28.4b.  That implies American stock investors wererunning trivial gold allocations around0.11%!  That’s on the order of only 1/50ththe minimum 5% that’s been universally advised for centuries if not millennia.  So it’s not much of a stretch to argueAmerican stock investors had zero gold exposure, they were effectively all-out.

The sharp stock-marketselloff in the few months since those halcyon all-time record highs hassurprised most, but it shouldn’t have. As Q4’18 dawned, something ominous happened that was unprecedented instock-market history.  The US FederalReserve upped its quantitative-tightening campaign necessary to start unwindingits $3625b of quantitative-easing money creation over 6.7 years to its terminal velocity.

October 2018 would bethe first month ever to see the Fed’s monetary destruction ramp to a staggering $50b-per-month pace.  And even to unwind just half of the Fed’s radicalQE, QT would have to keep on destroying $50b per month of QE-conjured money for30 months!  At the end of September whenthe SPX was just 0.6% off its all-time record high, I explained all this indepth warning it was this bull’sdeath knell.

And indeed within aweek of Fed QT going full-throttle, the SPX started to slide.  There was no way QE-levitated stock marketscould ignore QT obliterating that QE money. Every daily selloff since had its own unique story and specific drivers,which I discussed and analyzed in our subscription newsletters.  These all added up to enough selling to spawnan ongoing stock-market correction, an SPX selloff exceeding 10%.

Blame it on Fed QT, stock-market bubble valuations, mountingUS-China trade-war threats, Republicans losing the House, or whatever you want,but by Black Friday the SPX had fallen 10.2% over 2.1 months since thateuphoric record peak.  The stock marketsstaged some sharp rallies within that span, but they quickly fizzled proving tobe dead-cat bounces.  This recent action is ominously looking very bear-marketlike.

We can’t know for surewhether the long-overdue new bear market driven by epic record Fed tighteningis indeed upon us until the SPX falls 20%+ on a closing basis.  This recent correction would still have to double to hit that bear-marketthreshold.  But gold has certainly beenthe main beneficiary of the recent stock-market weakness.  Investors are starting to remember the ages-oldwisdom of diversifying into gold.

This week’s chart looksat the US-dollar gold price superimposed over the SPX during the past 4 yearsor so.  Despite gold being forgotten inrecent years as the stock markets surged ever higher, it remains in a youngbull market.  And that was spawned by thelast set of back-to-back corrections in the SPX, which catapulted gold sharplyhigher.  We’re likely on the verge of anotherstock-selloff-driven major gold upleg!

GLD’s physical-gold-bullionholdings held in trust for its shareholders reveal how American stock investorsfeel about gold.  This past spring theystarted slumping as gold was sold to move even more capital into the lofty USstock markets.  For 5 months in a rowending in September, GLD’s holdings retreated as investors dumped GLD sharesfaster than gold was falling.  By earlyOctober GLD’s holdings hit a 2.6-year low.

I penned a whole essayon this stock-euphoria-driven goldexodus in late September, explaining why it was happening and why it was likelyto soon reverse.  And that shift ingold-investment sentiment began the veryday the SPX started plunging in mid-October!  Up until October 9th the stock markets lookedtotally normal, the SPX had only drifted a trivial 1.7% lower from itspeak.  Everyone remained wildly bullish.

But something snappedon October 10th, that fateful day the SPX plunged 3.3% out of the blue on nocatalyst at all.  Heavy technically-motivatedselling accelerated led by the market-darling mega tech stocks.  For years investors had believed thembulletproof, their businesses so good they could weather any stock selloff oreconomic slowdown.  Fears surged on theworst SPX down day since back in early February.

That very day Americanstock investors started returning to gold. They poured capital into GLD shares so aggressively they forced a major 1.2%holdings build.  GLD’s mission is totrack the gold price, but it has its own supply-and-demand profile independentfrom gold’s.  So when GLD shares arebeing purchased faster than gold is bought, GLD’s share price threatens to decoupleto the upside on that excess demand.

So GLD’s managers mustvent that differential buying pressure directly into the physical gold marketin order to equalize it and maintain tracking. They do this by issuing enough new GLD shares to satisfy all the excessdemand, and then plow the cash proceeds into gold bullion.  Thus rising GLD holdings show Americanstock-market capital is flowing into gold.  That proved to be GLD’s biggest build in 6.7months.

That fateful day proved a major inflection point for bothnear-record US stock markets and the extremely-unpopular gold.  As the SPX continued to weaken over the nextcouple months, GLD continued to enjoy modest builds on investment goldbuying.  By late November GLD’s holdingshad climbed a considerable 4.5% over 6 weeks. That has helped push gold 5.5% higher since its mid-August lows, a solidyoung upleg.

Odds are that goldbuying via GLD by American stock investors isonly beginning.  The longer thisstock-market weakness persists, the deeper their worries will grow.  And the more their stock-heavy portfoliosbleed, the quicker they will remember they should’ve allocated 5% to 10% to gold.  Once gold investment demand is kindled by fallingstock markets, it tends to balloon dramatically and take on a life of its own.

Gold’s young bullmarket today that was forgotten this summer began as 2016 dawned.  Much like this year, in the first half of 2015the US stock markets were powering to dazzling new record highs.  Since it seemed like stocks could do nothingbut rally indefinitely, gold was forgotten and shunned.  It slumped to a brutal 6.1-year secular lowby mid-December 2015, with investors really wanting nothing to do with it.

But their ironclad euphoriastarted to crack soon after the stock markets corrected.  In mid-2015 the SPX finally suffered itsfirst correction in an incredibly-extreme 3.6years after being levitated by relentless Fed money creation from its third quantitative-easing campaign.  Gold caught a bid on that 12.4% SPX selloffover 3.2 months, but then faded again into the expected first Fed rate hike in 9.5years in mid-December.

Then the SPX fell into another13.3% correction over 3.3 months into early 2016.  Seeing menacing back-to-back corrections after long years without one really deflatedgold-suppressing stock-market euphoria. So in early 2016 American stock investors began prudently rediversifyingtheir stock-dominated portfolios into gold. That birthed today’s gold bull, and the gold-buying momentum fed onitself to drive a powerful upleg.

Gold went from beingleft for dead in mid-December 2015 to surging 29.9% higher in just 6.7 months solelyon American stock investors returning! This is no generalization, the hard numbers prove it without adoubt.  The world’s best gold fundamentalsupply-and-demand data comes from the venerable World Gold Council.  It releases fantastic quarterly reportsdetailing the global buying and selling happening in gold.

Gold blasted higher onSPX weakness in Q1’16 and Q2’16. According to the latest data from the WGC, total world gold demand climbed 188.1 and 123.5 metric tonsyear-over-year in those key quarters. That was up 17.1% and 13.2% YoY respectively!  But the real stunner is exactly where those majordemand boosts came from.  It wasn’t fromjewelry buying, central-bank buying, or even physical bar-and-coin investment.

In Q1’16 and Q2’16, GLD’sholdings alone soared 176.9t and 130.8t higher on American stock investorsredeploying into gold after back-to-back SPX corrections.  Incredibly this one leading gold ETF accountedfor a staggering 94% of overall global gold demand growth in Q1’16 and 106% inQ2’16!  So there’s no doubt withoutAmerican stock investors fleeing into gold via GLD this gold bull never would’ve been born.

Gold was holding thosesharp gains throughout 2016 until Trump’s surprise presidential victory unleasheda monster stock-market run on hopes for big tax cuts soon.  Gold was pummeled in Q4’16 as American stockinvestors pulled capital back out to chase the newly-soaring SPX.  That quarter total global gold demand per theWGC fell 103.4t YoY or 9.0%.  GLD’s 125.8tQ4’16 holdings draw accounted for 122% of that!

Gold’s fortunes are beingdriven by American stock investors’ collective buying and selling of GLD shares. And nothing motivates them to redeploy capital into gold to diversifytheir stock-heavy portfolios like major SPX selloffs.  Recent months’ one has already proven seriousenough to rekindle differential GLD-share buying.  And as H1’16 proved, once investors startdriving gold higher its rallies tend to become self-feeding.

The more physical goldbullion American stock investors buy via GLD shares, the more gold climbs.  The higher gold rallies, the more investorswant to buy it to ride the momentum and chase its gains.  So buyingbegets buying, driving gold higher fairly rapidly.  And when stock markets are sliding, gold isoften the only asset class rallying. That makes it even more attractive to investors getting pounded bysliding stocks.

This latest SPXcorrection is even more damaging to sentiment because it is 2018’s second one.  Back in early February the SPX plunged 10.2%in 0.4 months, which started to crack sentiment.  Back when this gold bull was born it was thesecond of back-to-back SPX corrections that proved the coup de grâce in hurtingstock-market sentiment enough to unleash a reallocation into gold.  This scenario is playing out again.

Provocatively seeingthe three major US stock indexes suffer two 10%+ corrections within any singlecalendar year is itself a super-bearish omen. 2018 joined 1973, 1974, 1987, 2000, 2001, 2002, and 2008 as the SPX’sonly other dual-correction years.  Thosecoincided with a 48.2% SPX bear, a 20.5% single-day SPX crash, another 49.1%SPX bear, and a third 56.8% SPX bear!  Allthree bears triggered recessions.

This stock-market weaknessisn’t only likely to persist, but the odds really favor it snowballing into anothermajor SPX bear market.  Gold investmentdemand will naturally surge as stocks burn, fueling a strong bull market.  Gold’s 29.9% gain over 6.7 months at best sofar in this bull is nothing.  Gold’s lastsecular bull from April 2001 to August 2011 saw it soar 638.2% higher!  Gold’s gains as the SPX rolls over should bemassive.

With a trivial 0.1%portfolio allocation to gold, what happens to gold prices if American stockinvestors just return to a still-immaterial 1.0%?  That’s still way under the 5% to 10% recommendedin normal times, and plenty of great investors believe 20% gold allocations arenecessary during stock bears.  Gold’supside from here with virtually-zero US-stock-market capital allocated to it isvast.  And it could accelerate ratherfast.

The timing of this currentSPX correction is likely to magnifybearish psychology.  It has occurredentirely within Q4’18.  The SPX exited Q3’18just 0.6% off its record peak from a week earlier.  So I suspect a lot of American retirement investorshave no idea just how much carnage their precious capital has suffered.  When they get their quarterly statements fromtheir money managers in January, they could really freak out.

Even worse, far toomuch of this retirement capital was allocated to the market-darling mega techs which were the biggest holdings across most funds.  Their losses have far outpaced the SPX’s.  As of that latest correction low on BlackFriday when the SPX was down 10.2%, Apple, Amazon, Microsoft, Alphabet,Facebook, and Netflix had collapsed 25.8%, 26.4%, 10.8%, 19.9%, 39.4%, and 38.2%from their all-time highs!

The mega techs that nearlysingle-handedly pushed the SPX higher for years averaged 26.8% losses, or 2.6x the SPX’s!  When investors who don’t closely follow thestock markets figure that out next month, the investment demand for rallyinggold ought to explode.  The first half of2019 has a setup much like H1’16, where gold essentially powered 30% higher.  A similar upleg from mid-August’s lows isn’ta stretch at all.

Another 30% run from$1174 would leave gold at $1525.  Andonce gold climbs decisively back over its bull-to-date high of $1365 from early-July2016, investment interest and demand willsoar.  Just like the mega techstocks, the higher gold prices the more investors want to buy it.  A mere 16% gold upleg off August’s lows, or another10% higher from this week’s levels, would near that psychologically-huge bull breakout!

All investors should always have 5% to 10% of their investablecapital allocated to gold.  But almostnone do today as a long-overdue bear market fueled by epic record Fed QT looms.  If you don’t have that core gold allocation,you need to get it in place before stocks fall much farther and gold surgesmuch higher.  The gold miners’ stocks willgreatly leverage gold’s gains too, their leading index soared 182.2% largely inH1’16!

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The bottom line is thisstock selloff is boosting gold.  Flagginggold investment demand turned on a dime when the stock markets started plungingin mid-October.  Gold has rallied on balancesince as American stock investors start redeploying capital.  Their buying alone via GLD shares was fully responsiblefor gold’s sharp 30% upleg in 2016’s first half.  That followed the last back-to-backcorrections in US stock markets.

And between record Fed tighteningrunning full-throttle, continuing dangerous bubble valuations, and the mountingtrade wars, this recent stock selling is likely to persist on balance.  So gold investment will look far moreattractive.  Coming from virtually-zerogold portfolio allocations, investors have massive buying to do.  The higher they push gold, the more otherinvestors will chase it.  Especially as USstock markets weaken.

Adam Hamilton, CPA

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