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Will declining stock and bond prices fillip the price of gold?

Richard Russell, famed for his Dow Theory Letters and his interpretation of the Dow Theory, recently declared stocks to be in bear market.  In his July 5 Remarks, he discussed the bond market, saying that the bond market is to the stock market like King Kong would be to a five-year old girl.  He then provides evidence that the bond market is crashing because of the perception that the Fed is considering cutting back on QE3.  Russell fears a bond market crash will precipitate a stock market crash.

Also recently, Tom Fitzpatrick discussed with Eric King of gold’s price action in relation to the stock market action 1973-1974.  Fitzpatrick said: Between 1973 and 1974 the DJIA fell 45%.  As the equity market then recovered gold went into a corrective phase within 3 months that saw it fall 44% as the equity market rallied.

Fitzpatrick sees gold’s recent price weakness as being similar to gold’s 1973-1974 price-decline because of the current bull market in stocks.  However, if stocks decline, as Russell fears, gold should see upside movement.

My position: if stocks decline in a big way, the Bernanke Fed will make it clear that quantitative easing will not only continue but will be increased.  (See Russell’s comments on this below (bolded).  Further quantitative easing or other such printing press schemes should renew interest in gold and silver.
Russell’s Remarks and Fitzpatrick’s discussion on KWN are worth the time required to read them.  They provide excellent understanding of the relationships between stock prices, bond prices, interest rates and gold prices.

July 5, 2013

I want to make this clear. I have presented my theoretical scenario (of a bear market in stocks), but my scenario is certainly not a guarantee of accuracy. In the end, I go by what the market is doing, and what I believe the market is telling me. If market facts change, I change. I’m always trying to construct a scenario based on the latest “market language,” as I interpret it.

For instance, if the Dow, the Transportation Average, the S&P, GDOW and bonds all break out to new highs on increasing volume, then the markets will be telling me that we will be enjoying good times for a least the next six months to maybe a year out.

But barring such a bullish series of events, I’ll stick to my scenario of deflation, deleveraging and hard times ahead. You see, for me the fascination of the market lies in its uncanny ability to discount the future — all this, based on the hope that I have the ability and know-how to accurately read what the markets are saying or predicting.

“Reading” the markets isn’t a mechanical process. It’s not tantamount to solving a geometric puzzle — far from it. Reading the market is a matter of experience, intuition, and knowledge. Reading the markets is often a matter of what studies to include and what studies to leave out.

And it’s also a matter of timing. The graveyards of Wall Street are filled with brilliant men who were right too soon.

OK, now let’s get down to business. Compared with the stock market, the bond market is like King Kong standing next to a five year old girl. The bond market includes the Treasuries, municipal bonds, corporate bonds, agency bonds, junk bonds and even preferred stocks which tend to act as bonds.

The Federal Reserve controls only short rates. The Fed sets the rate on short T bills and short debt. But the mighty bond market is a free market, and its rates are set by investors. When investors feel optimistic, they may buy bonds for income. When optimistic investors buy bonds, the bonds will rise, at which time the yields (rate) on the bonds declines. When investors are bearish on bonds they will sell them, and the yields will rise.

Below we see the Boxx high yield corporate bond fund. In bond language, high yield means junk. These are low-rated bonds commonly called junk. Since they are low quality they normally must provide high yields. But the desire for income has been so urgent recently that the yield on some junk bond funds has declined to an almost unheard of low of 5%. The whole world of bonds has been shaky recently, and thus we see the junk bond fund pictured below in a sharp correction (or is it part of a bear market in bonds?).


Below we see the YIELD on the bellwether 10 year T note surging (today) to a new high. Of course, this is Bernanke’s worst nightmare, since the Fed has been doing everything in its power to bring interest rates down. The chart shows the rise in rates from May’s 1.61% to today’s 2.71%, all within a period of less than three months. With today’s surge in rates above 2.7%, I’m surprised that the stock market wasn’t hit harder (but note today’s low volume — professionals are being very careful regarding the stock market).


What we may see ahead is a crumbling of the huge bond market. No wonder Bernanke doesn’t want another term in office.

The thing Bernanke is most afraid of is — deflation. Declining gold prices and a rising dollar are deflationary.

Declining bonds (rising rates) are also deflationary. I think that if further signs of deflation appear and if bonds continue to decline, the Bernanke Fed may even raise its monthly bond and mortgage-backed securities buying to $100 billion or more a month. Bernanke’s creed — deflation must not be allowed to occur, no matter what it takes.

Short term charts can be deceptive. For instance, over the short-term the US dollar appears strong, as you can see via the chart below. This has been a factor in gold’s decline.


However, I include (below) a ten-year chart of the dollar, and what we see here is a series of declining tops. So over the long run, the dollar has been losing purchasing power. This is the chart that bothers China and other nations who hold large amounts of dollars in their reserves. With the Fed creating a trillion more dollars every year. I expect the uptrend line on this chart to be broken.


Below we see the 30 year Treasury bond, having dropped from 148.60 to 133 in less than three months. In the steady and slow-moving bond market, this is tantamount to a crash. The big question — where to next?


Russell advice — The markets are being manipulated in all areas. I don’t trust manipulated markets — they are dangerous and are not normal or “natural,” and you never know what the manipulators (the Fed) will do next. Therefore, my preference is to be on the sidelines watching the shenanigans.

This is a difficult, thin market where amateurs are matched against professionals. So ask yourself, why should you, as an amateur (playing in a difficult and overpriced market) be able to beat professionals at their own game?

Russell observation — the only time amateurs and pros are even is at a major bear market bottom, at which time amateurs and professionals are equally scared to death. The amateurs are scared because they’ve never seen anything like it, and the professionals are frightened because they’re losing their shirts.

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