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The Federal Reserve's willingness to
"push on a string" is good news for gold stocks.
It's been a grim set of trading
sessions for the major indexes. The S&P 500 has been drawn like a magnet
back to its all-important 200-day exponential moving average -- a support
level being breached as I write.
The carnage of recent days is not so
much due to the debt ceiling debate, but rather to what investors see beyond
it. The fear can be summed up in three words: Global Economic Slowdown.
Harsh cuts will be needed to fulfill the terms of the debt ceiling deal. Healthcare
stocks have been pummeled as Medicare payments look
set to shrink. In other areas of the economy, a lack of construction jobs has
kept unemployment high. A retreat in government jobs as states and cities cut
back has also hurt the norm.
Mr. Market
looks at all this and sees a recovery on the ropes. Long-term Treasury bonds
are rising, and yields falling, in a classic slowdown signal. Nor is the
United States the only wet blanket. Manufacturing data show that the U.S.,
China and Europe are all slowing. In a mirror image of falling U.S. yields,
U.K. gilt yields recently hit record-low levels and German yields went to
zero.
There isn't much faith that the
previous stimulus-enhanced growth will stick. Instead, there is fear of the
government stepping back.
As Bloomberg notes,
The federal government looks to be
getting out of the business of trying to spur the economy just as the U.S.
expansion shows increasing signs of faltering.
A deal struck over the weekend to cut
$2.4 trillion or more off budget deficits over a decade marks the beginning
of a prolonged effort to put the government's finances into better shape.
While the immediate economic impact from the agreement is likely to be small,
it will add to a reduction in growth next year of 1.5 percentage points
coming from the expiration of past stimulus programs.
But in a curious divergence, gold and gold stocks have been holding up well
even as the broader market weakens. Gold stocks, as proxied
by the Market Vector Gold Miners ETF (GDX:NYSE),
are still above their 20- and 50-day moving averages. Not so for the major
indexes.
Why are gold stocks holding their own, at least thus far? For the same reason they
have done well in deflationary times past.
To put it simply, gold stock investors
have a friend in Ben Bernanke. The Chairman of the Federal Reserve is known
to be stimulus happy, willing to support the economy -- or rather the paper
asset market -- whenever he gets the chance.
In times of economic slowdown, and
especially in the aftermath of financial crisis, stimulus is like a drug that
quickly wears off. The first shot in the arm feels great. The second shot,
not quite so fantastic. By the third shot, senses are dulled. The arm starts
to feel numb.
When the economy stops working, and everything is still down in the dumps, the
Federal Reserve starts "pushing on a string." That's what they call
it when money is pumped into the system without rational thought for whether
it's a good idea.
It is the "pushing on a
string" that encourages gold stocks. The extra money does not help the
actual economic situation, but it does find its way into paper assets.
The more that things
stay bad, the more the Federal Reserve is tempted to "do"
something. This activity usually debases the currency. In present times, the
dollar and the euro both look to get trashed. That leaves gold.
A final requirement for gold
stocks to do well is a relative lack of competition. When growth-oriented
stocks are rocking and rolling, it is harder for investors to get excited
about the metals space.
That is why the current backdrop could
be massively appealing for gold stocks. Many sectors of the market are washed
out, the general trend looks weak, and there is a desperate need for places
to hide.
At the same
time, with the government cutting back spending, the Federal Reserve is
likely to try and save the day again. Their dollar-abusing ways could go
straight to benefiting gold and gold stocks, even as the rest of the
market stays stuck in a slump.
Justice
Litle
Taipan
Publishing Group
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