Gold to World: Mo' Money, Mo' Flation
Markets may be saying that the more money that's out there, the less inflationary it actually becomes. The implication? Stocks are more of an inflation hedge than gold, because stocks are the driver of inflation now.
One should expect that the expected can be prevented, but the unexpected should have been expected.
--Norman Ralph Augustine
Over the last several months, it feels like we've entered Bizarro World. The Fed "shocked the world" by announcing QE-infinity, and yet market internals since mid-September up until very recently acted in a very deflationary way. Since the end of September, I have been highlighting this deterioration, addressing the idea that the market seems to think that unlimited is not enough when it comes to the Fed. Whereas QE1 and QE2 were greeted as inflationary, open-ended QE3 seems to be having the exact opposite effect.
I suspect that the market has realized that the Fed has given up its most powerful weapon of all: the element of surprise. By promising that rates would be low for essentially as long as it takes, the Fed has removed any sense of urgency by investors to borrow. After all, why take advantage of low rates now if they will be in place tomorrow? What's the rush? Perversely, while money printing is perceived as inflationary, unlimited monetization is being treated as deflationary. Mo' money, mo' DEflation.
The stock market itself, then, becomes far more of an inflationary force on the economy through increased collateral values than QE. This has important implication on gold, which is often seen as an inflation hedge. Take a look below the price ratio of the SPDR Gold Trust ETF (NYSEARCA:GLD) relative to the S&P 500 (NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/GLD is outperforming (up more/down less) the denominator/SPY.
First, note that gold relative to the S&P 500 is bumping up against a resistance line that has been in place over the past three years. In 2010, gold underperformed stocks when "inflationary" QE2 was enacted (ratio down), outperformed in early 2011 and in the middle of the Summer Crash (deflationary period), and has since tread water against stocks in 2012. What is most interesting is that underperformance in gold coincides with QE "inflation" sentiment, while outperformance more coincides with deflationary forces. This would imply that it is the stock market that is the driver of inflation (making equities more sensitive from an asset class performance standpoint), and that when stocks fall, the loss in equity market cap which is from an aggregate standpoint deflationary makes gold lead.
If gold outperforms stocks, it implies deflationary -- not inflationary -- fears within the precious metal space may be rising. Note that gold may be on the verge of a downtrend after hitting resistance. Could this be an indication that stock strength will return and that new highs are still possible? If QE3 does not matter and the direction of stocks is now the driver of inflation, could underperformance in the yellow metal mean the bull market in stocks still has legs?
A fascinating turn of events – in a world where gold is limited and the supply of shares is shrinking due to company buybacks, it appears stocks are the new gold.
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