The stock market may have rebounded, but it’s still extremely volatile. That’s because there are growing concerns about the global economy (especially China), a larger number of central banks having adopted negative interest rates, corporate earnings that are way down, and stocks that are overvalued. Thanks to the cyclical nature of the stock market and the gloomy outlook, gold continues to be an excellent short-term defensive play. I say “short-term” because the markets will eventually recover in a meaningful, sustainable way. But until that happens, it would be a huge mistake to ignore the ongoing potential gold has to offer.
Global Economy Remains Muddled
The first quarter is over and we’re back to where we started. The extreme volatility that rocked the markets at the start of the year is only a memory, especially after Federal Reserve chair Janet Yellen’s dovish comments about interest rates and fears about the global economy and weak commodity (oil) prices lit a fire under stocks last week.
But the long reign of artificially low interest rates and easy money is only in place because the global economy is doing poorly. And stocks are only climbing, or rebounding, because central banks continue to financially engineer the markets.
As long as investors remain confident in light of a lackluster global economy and the markets throw up the occasional surprise, Wall Street will cheer.
Here’s what we know: America has low unemployment, but no wage growth. We have had a prolonged period of ultra-low interest rates, but this has not encouraged businesses to invest. What it has done is made it easy for businesses to borrow money, buy stocks, prop up share prices, and sit on hordes of cash.
After years of quantitative easing (QE), unemployment is low, wages are low, inflation is low, and gross domestic product (GDP) is low. That’s not exactly what the Federal Reserve was hoping for when it started its generous bond-buying program back in 2008.
And the future doesn’t exactly look bright. The World Bank, the Organisation for Economic Co-Operation and Development (OECD), and the International Monetary Fund (IMF) continue to overestimate the strength of the global economy and continually revise their outlooks lower.
The OECD cut its 2016 global growth forecast from 3.3% to an even three percent, the IMF lowered its 2016 outlook from 3.6% to 3.4%, while the World Bank projects 2016 global GDP growth at just 2.9%, as the global economy recovers much more slowly than initially projected.
Weak Economy Makes Gold an Excellent Short-Term Play
The rollercoaster ride of the first quarter is over and earnings season is right around the corner. But don’t expect any real sustainable bright spots. The blended earnings decline in the fourth quarter was -3.3%. In the first quarter of 2016, earnings are expected to decline by 8.7%. In a recovery, we’d like to see those numbers actually improve.
As we head into the second quarter, it’s also important to remember that equities tend to reach a seasonal peak in April before taking a breather until the fall. This doesn’t bode well for the markers either.
As an investor, it’s important to keep an eye on what the markets are doing. And that doesn’t mean just reading the headlines. “Yellen rally hits day two, sending stocks to 2016 highs,” sounds pretty good—but it’s all relative.
When it comes to investing, it’s important to have a healthy dose of contrarianism. The stock market is volatile, earnings are weak, and the global economic outlook is lackluster. It doesn’t mean it’s always going to be this way. But investing is about taking advantage of market conditions.
Chart courtesy of www.StockCharts.com
Gold was an inflation hedge in the 1970s, then the precious metal retreated. Gold went on a spectacular run after the events of 9/11 and during three rounds of QE before retreating. Today, it’s on another run over growing concerns of a global economic slowdown and fears that central banks have run out of options. But this, too, shall pass and gold will retreat.
For now, gold remains an excellent defensive play that shouldn’t be discounted, especially while central banks fawn over negative interest rates, stocks are overvalued, earnings are down, and the global economy, while not in a technical recession, is definitely stuck in a rut.