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High volatility in
the markets seems to have
become the norm lately. Equity markets around the world have whipsawed investors, as the
indices swing wildly up and down in roller-coaster fashion. And the unruly changes from one day to the other are not small. When the Dow shed 520
points in a day last week,
it represented a loss of $1.6 Trillion in capital for equity
holders.
Likewise, stock market rallies last week were sharp
and short-lived, only to
reverse in further massive selling.
It’s no wonder that many investors
have decided to head for safe haven assets.
There are many reasons for the recent high volatility in the markets. A major cause was the
US debt ceiling deal. The
markets sold off sharply when the deal was announced, which surprised some that thought
that that raising the US debt ceiling would have a stabilizing effect and save the nation’s AAA credit rating. The markets reacted negatively on news of
the deal, and by selling off on Thursday, August
4th, correctly anticipated
Standard and Poor’s decision
of Friday, August 5th to downgrade, for
the first time ever, the credit
rating of US sovereign debt.
In its press release,
S&P said that “political brinkmanship”
in the debate over the debt
had made the U.S. government’s
ability to manage its
finances “less stable, less
effective and less predictable.”
It said the bipartisan agreement to find at least $2.1 trillion in
budget savings “fell
short” of what was necessary to control the debt
over time and predicted that
leaders would not likely achieve more savings in the
future. The debt deal ducked
the central issue, namely reducing
runaway government spending.
Failure of the US government to solve its debt
crisis was not the only factor that roiled the markets last week. A slew on new unfavorable economic data also pressured stocks. Consumer
Sentiment, a key indicator of consumer demand, plunged in August to the lowest
level since May 1980, adding to concern that weak employment
gains and volatility in the stock market will cause households to retrench. The
Thomson Reuters/University of Michigan preliminary index of consumer
sentiment slumped to 54.9 from
63.7 the prior month. The
measure was expected to decline to 62, according to the median forecast in a Bloomberg News survey.
Unemployment remains high at 9.1% with no signs of improving. Food and energy costs continue to rise; buying power of the Dollar is shrinking, and wages are not keeping up with rising household costs. Housing values continue
to fall, while rents are rising.
The Federal Reserve signaled its pessimism on the prospects of the US recovery
by announcing it would maintain near-zero interest rates to
2013. The markets rallied
briefly on the uncommon certainty of the Fed statement,
only to sell-off again on the realization that the economy is grinding to a halt. US economic growth for the first quarter was revised down to 0.4%, down from 1.9%.
Most economists, including
those at the World Bank, see US growth slowing, not accelerating over
the next months and years. According to the World
Bank, the US is leading
the global economy into a
“Danger Zone” of likely recession. The odds of a US double-dip recession are now 1in 3 according to economist survey data.
Fears of insolvency in Italy,
Spain and maybe France and the uncertain
response by the ECB also weighed on investors. European markets sold off, and the US markets followed with more selling. The question remains whether the EMU will survive chronic bailout measures, or the weaker members are allowed to fail and then cut away from
the stronger Eurozone members.
One reliable measure of market volatility is the VIX Index.
VIX is the ticker symbol for the Chicago Board
Options Exchange Market Volatility
Index; it measures the implied volatility of S&P
500 index options. We can
see at once that the VIX reflects market sentiment. When the VIX is high, markets
tend to swoon. When the
VIX is down, the markets
tend to gain. We see this dynamic in the chart below. Just before the market sell-off of 2008, the VIX reached
80. The VIX also climbed
to 48 in May 2010 and reached 48 again last week, each time corresponding to big sell-offs in the S&P
500.
The Sturm
und Drang that plays out in wild swings in the markets that ruin portfolio values and
destroys wealth does not
affect those that have prepared themselves against the onslaught. The key to the preservation of wealth is diversification. In today’s volatile economic
environment, investors
are finding once again, that owning gold provides stability as well as a store of value.
We can see how
a portfolio that is diversified with gold performs well when the markets are volatile.
Gold tends to be much less volatile than the general markets. Because gold has intrinsic value, gold is considered the premiere safe-haven asset. In uncertain economic times, investors cash out of stocks and low-yielding
bonds and purchase gold. Significantly,
today we are seeing the central banks are buying bullion. The World Gold Council's most recent figures show central banks
are net buyers of bullion.
In the first half of this
year central banks net purchases totaled 208 tonnes of
gold. In 1981, ten years after the end of Bretton Woods, the largest annual net gold purchase by central banks was 276 tonnes of gold bullion.
Gold is proving once more
it is the universal reserve currency. By the way, it was 40 years
ago today that President Nixon took the US off the gold standard.
So how does gold hold up for the individual investor in volatile times? The answer
is straightforward: Gold outperforms the markets in
turbulent times. We can see the evidence in the chart below. It compares price action of the Dow vs spot gold over the last few months.
What is significant
here is highlighted in the oval. It
shows the 13% decline in the Dow in last week’s big sell-off, and gold climbing to
over $1800/oz. Investors that have owned gold in a diversified
portfolio protected their
wealth, while those that relied
on stocks were savaged by
the sell-off.
The DJIA has lost 1.18% year-to-date.
The S&P 500 has lost 4.54% year-to-date.
The Model Conservative Portfolio available to subscribers of The Gold Speculator
has returned 43% year-to-date. So for us, in these
turbulent and volatile economic times, the order of the day is “Steady as She Goes.”
Investors from around
the world benefit from timely market analysis on gold and silver and
portfolio recommendations contained
in The Gold Speculator
investment newsletter, which
is based on the principles of free markets, private property, sound money and Austrian School economics.
Scott Silva
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