What Gold Can Tell Confused Investors About Short-Term Stock Prices

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This has been an interesting week so far. Conglomerates are down, tech and commodities are split, and banks enjoyed a big boost on Tuesday as investors priced in a steeper yield curve. Still, traders seem to be a little confused about where the market “should” be going.

What Gold Can Tell Confused Investors About Short-Term Stock Prices

Some of the confusion has been due to the correlated movement of stocks and long-term Treasury bonds. Generally, these two asset classes are negatively correlated. The relationship is strong enough that bullish bond signals are often used by traders to initiate a sell signal on stocks — and vice versa.

As you can see in the next chart, Treasury bonds and the S&P 500 Index had been trading higher since July 7. This happened through mid-June as well, which was followed by some minor volatility in stocks late last month. However, the normally negative correlation has largely been reversed since May.

What Gold Can Tell Us About Short-Term Stock Prices-Chart1

S&P 500 vs. iShares Barclays 20+ Yr Treas.Bond (ETF) (NASDAQ:TLT)


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Hazy Outlook

Historically, a correlation like this has been bad for stocks because it indicates that investors are moving toward safety. For example, in June 2016, the two markets trended together, which likely helped motivate selling into the U.S. election in November.

The challenge of a correlated market like this is that the outlook gets hazy, and price movement in individual stocks is more random.

One way for us to deal with this issue is to include another interest-rate-sensitive asset class in the analysis. If the signal is clear from the third asset class, we should be able to do a better job of predicting further upside for stocks (or a reversal) because we can infer what that signal is saying about underlying institutional behavior in the market.

The approach that seems most productive right now is to use gold as the third asset class. Gold prices have been stuck in a channel since February, unable to break to new highs. From a technical perspective, the price of gold is approaching a potential breakout to the downside. If a bearish breakout completes, it would tell us a lot about the way risk appetite is trending.

Emerging “Double Top”

Gold competes with fixed-income assets because it is a non-yielding asset that doesn’t accumulate equity value on its own. On a short-term basis, this means that higher interest rates make gold look less attractive, which is why it has such a strong positive correlation with bond prices. 

As you can see in the next chart, gold prices are approaching the breakout point from an emerging “double-top” reversal pattern.

What Gold Can Tell Us-Chart2

SPDR Gold Trust (ETF) (NYSEARCA:GLD)


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A breakout on gold would confirm expectations for higher long-term interest rates, which ironically tends to be a good thing for stocks. For example, although the banking sector is only 13%-14% of the S&P 500, it represents 20% of the index’s profits. Banks, brokers, exchanges and insurance companies do well in a higher interest-rate environment (except during recessions), which should spur investment and higher equity prices in general.

 

However, let’s not count those golden eggs before the hatch (or crack) because the gold breakout hasn’t resolved yet. Confirmation seems likely at this point, but, between then and now, we’ll get today’s reaction to the Fed announcement and more earnings reports. Expectations can be fickle when stock valuations are in nose-bleed territory, like they are right now, so we want to make sure there is confirmation before drawing firm conclusions.

Bottom Line on Gold

Most major asset classes look a little mixed right now. Europe is attractive on average, but outside Germany and France, the rest of the region is still shaky — with more bailouts likely. Stocks in the U.S. are doing well so far, but advertisers and conglomerates are down, which can sometimes signal early problems for the major indexes.

Finally, bonds and stocks have been trending together, which blinds traders from an important source of information and confirmation. Watching the breakout on gold (assuming it completes) can do a lot to relieve some of the uncertainty in the market.

InvestorPlace advisors John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.

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Article printed from InvestorPlace Media, https://investorplace.com/2017/07/what-gold-can-tell-confused-investors-about-short-term-stock-prices/.

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