The S&P500 chart shows that the recovery been heavily overbought and probably due for more downside correction. The market is not going to recover to previous highs any time soon, and with deflationary pressures in the economy, it is more likely to have a larger move down over the next year to 18 months.
Companies are sitting on mountains of debt that is likely to be downgraded as damaged Q2 earnings reports begin to print this summer. Right now stocks are in a sideways, though highly volatile, lull until we learn the true damage that the shutdowns had on cumulative US production and the supply chain. Early winners are online retail shopping, due to closed shops in the 50 states, while early losers are the hospitality and airline industries. However, the damage will likely run much deeper than this in core pools of economic output.
We expect to see creeping damage in the commercial and residential real estate sectors. All of those millions of lost jobs will eventually result in rising evictions. Those evictions will lead to spiking defaults on real estate loans, causing lenders to beg for more bailouts from the Fed.
All of the above factors will lead to much more easing by the Fed to support a deflating economy. Lenders are beginning to tighten credit, leading to a squeeze on banks desperate to avoid escalating loan defaults that are threatening share holder equity.
Balance sheet gearing of 12-1 and much higher of bank liabilities to shareholder equity means that either the government prints trillions to bail banks out of the credit contraction cycle, or face a financial catastrophe that very well could be many times worse than what we witnessed in 2008-09.
Downstream, brick and mortar food stores will begin to come under much more pressure. The cash handouts to small business owners and hourly workers is a pittance compared with earnings. Part time workers don’t qualify for unemployment benefits in many states, though the CARES act does adjust who can apply for them.
While people are stockpiling supplies now, they will run out of money for food after they default on rent and mortgage payments if the economy doesn’t fully reopen immediately and the jobs are restored. The consumer had no savings to start off with, and the shutdowns are exacerbating existing problems with late cycle credit peak for businesses with falling revenues who cannot take on new employees due to debt service.
Economy Will Turn Up Before Beginning Stronger Contraction
We live in Texas, and our governor began a partial reopening of retail last week by allowing drive-up service. The governor is also expected to announce more reopenings this week, with other states like Georgia and Oklahoma participating.
State governments are somewhat timidly approaching business as usual while watching the COVID infection numbers published in the media. Should they begin to spike again, it is likely we will see some states tighten restrictions and implement new laws on use of masks and gloves in public.
The economies will begin to turn around a bit, but not after the damage has been done. We expect that the late cycle credit bubble has been pricked by the coronavirus, and deleveraging will start in earnest in the financial sector. The Fed will try to backstop the economy, but it would have to print trillions to do so and eventually that game ends. Other nations have already begun de-dollarizing and purchasing up their gold stocks to support central bank balance sheets with the tier 1 asset. The forces are already in place moving the world into a multi-polar economic model.
All of the foregoing is bullish for gold from a fundamental standpoint. Now we look at where gold is trading on the charts and what we expect to happen in the next year.
After the 2008-09 recession, gold rose very strongly and became overbought in 2012, as shown by the stochastic indicator. Gold has been in a bull since 2000 and had returned better than the S&P, DOW, or Wilshire stock indices in that time frame. There was likely to be some profit taking, and that occurred starting in 2011 after gold reached an all time peak.
What we see now in the gold chart is one of two things, and possibly both. We have upside momentum on recent financial fears that started with a rough Q4 of 2018 when the stock markets saw a healthy 20% correction. Since then, gold has been on an impressive run from $1200 up to its current perch in the mid-$1700s.
While the stochastic is flashing overbought, this signal is different than in 2011 when gold had been running up for over a decade. Since 2011, gold has been declining or sideways in all but two and a half of those years, forming the bottom of a cup. This indicates the market building some momentum on the downside which will propel gold forward.
For instance, we see a small head and shoulders form between 2015 to 2017, indicating gold’s run was not over. And during that time the average daily range readings don’t suggest high volatility or an over-extension in trading. In other words, gold has been quietly building momentum when coronavirus came along and provided a reason for gold to run to the upside again. Have we already fired our last shot with gold, or are we premature to the bigger move?
One may think that gold is overbought again and due for correction. Let’s examine why a short term correction in gold is still bullish. If the Fed’s plan works and their easing has a short term supportive effect, we could see banks ease up on tightening credit and businesses will begin to employ again. Anyone who thinks this will not take months for job remediation to occur; however, are banking on the government being able to push button start the economy for the first time in US history. This has never been done before.
If gold corrects, it forms a multi-year cup-and-handle formation which makes the chart immediately more bullish for the next 3-5 years. Given weakening economic fundamentals upon a deflationary wave stretching across the world economy, I expect more gold accumulation on any gold price correction. Upside momentum in gold will continue until the credit cycle resets, likely after a large number of bankruptcies and defaults. Whether that happens now, or 3-5 years from now, is just a matter of timing.