Gold, Yellen Say Be Open To Surprising Gains In Stocks

By: Chris Ciovacco | Tue, Jun 24, 2014
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Inflation tends to make bonds less attractive

Rising Inflation Makes Stocks More Attractive Than Bonds

Hypothetically, if we are earning 2.5% on a 10-year Treasury bond (IEF) and annual inflation rises to 3.0%, then our bond is producing a negative return on an inflation-adjusted basis. Thus, in a low interest rate environment, increasing inflation expectations tend to create additional demand for equities, which have a better chance of producing returns that outpace inflation.


Market Was Focusing On Inflation

Heading into the June 18 Fed statement and press conference, the market was wondering how Janet Yellen would react to rising inflation. The blurb below is from the June 17 edition of USA Today (one day before the Fed statement):

Consumer prices last month posted their sharpest increase in 15 months as inflation continued a recent acceleration from unusually low levels.


Yellen In No Rush To Raise Rates

The first clue the Fed was delivering a stock-friendly statement came as we were comparing the June 18 statement to the April 30 statement; the statements were very similar. The almost boilerplate language in the June statement meant the Fed was not going to try to "talk down" inflation expectations. From The New York Times:

Is the central bank ready to move briskly with unwinding its era of extraordinary stimulus in the economy, confident that the recovery will continue strengthening without monetary support struts? Or does the Fed expect to continue flooding the economy with cheap money well beyond the point where growth is truly robust? Ms. Yellen, less than half a year into her job leading the central bank, is already adept at saying a lot of words while conveying minimal new information. But if you read between the lines of her comments, she is clearly tilting toward the latter. She displayed no hint that her rate-increasing trigger finger was getting itchy.


Gold May Provide Some Insight

Since central banks can print new money, it is easier to increase the supply of U.S. dollars than gold (GLD). Therefore, many consider gold to be a "hard currency" or superior store of value during periods of rising inflation. In 2004, after gold completed the first step for a trend change relative to stocks by breaking above the blue trendline (see 1 in chart below), the stock market took another strong leg up, advancing 44% between mid-2004 and late 2007.

$GOLD:$SPX Gold (EOD)/S&P 500 CME/INDX


What Is Gold Telling Us Now?

Gold (IAU) has gained some ground since finding a short-term bottom on June 3. However, gold remains in a weekly downtrend relative to the S&P 500 (see chart below). Stock investors will get a probability boost if gold can complete a bullish turn relative to the S&P 500; something that has not happened yet.

GLD:$SPX SPDR Gold Trust/S&P 500 NYSE/INDX


Investment Implications - Anecdotal Evidence

Gold's correlation to the stock market lacks consistency. Therefore, we would classify this analysis as anecdotal evidence; helpful, but not something to exclusively guide allocation decisions. However, it is not unreasonable to assume that increasing inflation expectations could help propel stocks into a more speculative stage of this bull market, similar to 2004-2007 when the S&P 500 popped 44%. The chart of gold in isolation below (GLD) provides a guidepost for monitoring gold's progress. If GLD can close above $133.10 on a weekly basis, it would improve the odds for both gold and stocks, especially relative to bonds, looking out weeks and months.

GLD SPDR Gold Trust Shares NYSE

There are things to like about gold from a "keep it on our radar" perspective, but it also remains in a weekly downtrend relative to a diversified basket of bonds. The chart below needs to flip over to the bullish camp for the Yellen-induced pop in gold and stocks scenario to bear longer-term fruit.

GLD:AGG SPDR Gold Trust/iShares Barclays Bon NYSE

As noted in a recent "what could have investors done in 2008" analysis, it is important for us to wait for gold to complete bullish turns, rather than anticipating a turn. Regardless of what happens with the yellow metal, the big picture still favors the stock market bulls. Consequently, we continue to maintain exposure to stocks (SPY), and leading economic sectors (XLE). We still have exposure to bonds (TLT), but we have reduced that side of the portfolio two times over the past three weeks. As always, we will pay attention with a flexible and open mind, but Yellen's comment below about excessive risk taking aligns with the bullish case for stocks and gold:

"I don't see kinds of broad trends that would suggest to me that the level of financial stability risks has risen above a moderate level."

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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TRUE MONEY SUPPLY

Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
austrian-money-supply/