What Does a Broad Stock Market Correction Mean for Gold Stocks?

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by Marin Katusa, Katusa Research:

On Monday, February 5th, 2018 we experienced ‘Volmageddon’ (Volume Armageddon) where the low volatility indexes got crushed.

During Volmageddon, we experienced the largest one-day point drop ever for the S&P 500 at 113.19 points, but an overall drop of 124.21 points within 24 hours.

February 5th was the largest one-day point drop, it was nowhere near the all-time largest decline in percentage for one day. The largest one-day percentage drop still remains Black Monday, which was October 19, 1987. On Black Monday the S&P 500 fell by a stunning 23%.

Now, a lot has changed since Black Monday over 30 years ago, but there are similarities.

The 1987 crash came during a long a bull run starting in the early 80’s that emerged from a terrible recession. The long bull run had made many people complacent. So, of course people are saying a similar crash could happen again… and even usher in a bear market in stocks.

The age of irrational exuberance – coupled with the rise of quants (traders and analysts with complex mathematical and programming backgrounds) – makes it difficult to predict the end of any stock market rally.

Adding to the issue of capital movement and flight, Bitcoin even knocked on and poked its head thru the $6000 door earlier this week. At the same time, I’ve also seen a blockchain company that makes less than $5 million per year in revenue trade at a market cap of over a half of billion dollars. Some sanity would be good for the markets. And a healthy correction to reduce the froth is never a bad thing.

What we now know is that if the bull market in stocks and bonds is to end, the implications will be dire. This is because, historically, the Fed has always intervened to prop the market by lowering interest rates.

Today, interest rates around the world are still low. And more importantly, the new Fed Head just sworn in this week, Jerome Powell, has openly stated they plan on raising rates (if this proves not to be the case, he doesn’t have much room to go lower).

This means that the Fed would have limited options to stop the bleeding.

One viable option that remains is negative interest rates. If any President can pull off negative U.S. interest rates, President Trump is the one. Remember, Trump thought Trump University and Trump Taj Mahal in Atlantic City were also good ideas.

But I make my living putting money to work in the natural resource markets. And Fed moves impact the broader market equities and impact resource equities alike. So let’s take a look at the effect of a general market correction on our resource portfolio…

How Does Gold Perform in a Recession?

One way to get bear market insurance is to buy physical gold. In bear markets, gold tends to perform better than stocks. This is because investors see gold as a safe haven.

Year to date, the gold price has increased 1.0%. And history shows that gold tends to perform better than stocks in periods of recessions or market corrections. For example, gold peaked in 1980 when its price soared to $850 per ounce.

In the table below, you can see how gold tends to perform against the S&P 500 during the most extreme corrections since 1976.

Put differently, the chart below shows how gold performs during recessions (shown in red bars). The black line is the price per one ounce of gold.

The data shows that gold will perform better than the S&P 500 if or when there is a recession in the future.

There is a misconception that gold cannot do well in an interest rising environment. The fact is that in a rising interest rate environment, gold can – and has – increased in price.

Read More @ KatusaResearch.com