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Jan. 3, 2012, 10:15 a.m. EST
By Gil Morales & Dr. Chris Kacher
PLAYA DEL REY, Calif. (MarketWatch) "” As the New Year begins, a new round of QE is upon us "“ "Euro-QE" to be specific.
Investors have become conditioned to the effects of the U.S. Federal Reserve's quantitative easing actions in 2009 up to the present, more or less, which have been observed to produce grinding liquidity-induced increases in asset prices of all stripes, including stocks and commodities.
This has led to the somewhat complacent assumption that QE will continue to have the same effects, time and time again, each time it is deployed. The ultimate arbiter, however, of the effects of QE in terms of adding liquidity to and supporting the financial system at the margin will always be the markets.
This is why we find the action of gold quite puzzling within the conditioned paradigm of more QE = more asset price inflation. Gold has responded to the onset of Euro-QE backed by a Fed that has made dollars available to foreign banks at lower rates by moving decisively below its 200-day moving average. This begs the question: As we move into the New Year, what might the action of gold be telling us about the state of QE in January 2012?
As we see in Chart 1, the SPDR Gold Shares ETF /quotes/zigman/41663/quotes/nls/gld GLD +2.56% , a proxy for gold itself, has broken sharply below its 200-day moving average. The last time gold dropped below its 200-day moving average was August 2008, just before the big stock market break that began in September of 2008 and extended into October/November of that year. In that case, gold was signaling the start of a liquidity crunch that led to severe forced selling in stocks going into the third quarter of 2008. This was followed by another wave of selling that took the market to its ultimate lows in March of 2009. In the end it all added up to a rather harrowing experience for investors. Could gold be signaling another period like this for stocks just ahead?
We don't like to make predictions about where the market is going, since we adhered to the principle espoused by our mentor and former boss, William J. O'Neil, who advises that one doesn't have to know what the market is going to do, only what it is doing right now. And right now the action in gold is telling us that all might not be right in "QE-land" as we move into the New Year.
If gold presages another down leg in stocks, we would tend to look at this as a necessary "clearing of the decks" in the stock market given that we are now in the third year of a bull rally that began off the March 2009 market lows. Market corrections are often necessary, and investors should anticipate such events with opportunistic optimism since the seeds of every new bull market are sown during a market correction. If the irresistible force of mass fiat money-printing, the essence of QE, runs into what finally becomes the immovable object in a debt mountain that has grown well beyond reasonable proportions, then stocks could see some problems in the early part of 2012. They may very well be in a position to stage such a new down leg in a continuing market correction that may have been initiated with the sharp break off the market's peak in late July/early August of 2011.
This is our favored scenario and forecast for stocks; in fact, we believe a new down leg for the market that began in the early part of 2012 could result in a bottom perhaps some time in spring or summer. This would in turn potentially coincide with the market beginning to discount the potential for positive government economic policies and initiatives that could be catalyzed by the November 2012 election. On the margin, the potential for serious economic policy change could provide enough of an "inflection point" to spark a strong market rally phase at some point in the mid- to latter parts of next year.
Investors should always remember that the current market action is discounting the future. Therefore, if there are any positive changes in the works as a result of a change of power in the U.S. that would take effect in January of 2013, then the market should begin to discount that sometime in 2012. And a correction in stocks as we turn into the New Year, presaged by the action in gold currently, would set up exactly such a scenario. It is certainly one that investors looking for a silver lining amidst the world's turmoil might look for in 2012. While things could turn out worse given the fragile state of the global financial system, and other scenarios are possible, we think that the potential for an optimistic scenario has as good a chance as any as the market evidence plays out going into 2012.
Dr. Chris Kacher and Gil Morales are co-founders and co-managing directors of Virtue of Selfish Investing, LLC, publisher of the popular investment advisory service, www.virtueofselfishinvesting.com . They are the co-authors of "Trade Like an O'Neil Disciple: How We Made 18,000% in the Stock Market," (John Wiley & Sons, 2010). They do not currently have any positions in gold, either personally or through their clients portfolios.
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