Current convulsions in the global markets are coming as no surprise to my readers. I was greatly concerned by the overvaluations in the U.S. equity markets (SPDR S&P 500 (NYSE:SPY)) despite warning signs from the commodity prices that have hit record lows, indicating not all is well with the world economy. Gains in U.S. equities (SPDR Dow Jones Industrial Average (NYSE:DIA)) have been focused on only a handful of momentum growth stocks. A lot of these momentum hedge funds get stopped out on any decline. They may need to look for areas to protect profits from the past five year bull market. The downside could be significant, as there have not been any meaningful corrections in many years. I would not be surprised at another 20-40% on the downside for the overvalued large caps.
Despite equity markets hitting new highs, many of the sectors were already in decline. This historic crash over the past week has been fueled by one of the most overbought markets that I can remember since the dot com bust. After the dot com bust, investors sought out value in the deeply discounted commodity sector and junior miners (Market Vectors Junior Gold Miners (NYSE:GDXJ)). I expect history may not repeat, but it should mimic. After the dot com bust, junior mining was the place to be.
As the junior miners bottom, I expect the upward volatility to be at least equal and opposite to the recent five year decline originating with the deleveraging of the credit crisis. Stocks have been outperforming commodities over the past five years, reaching divergences not seen since the dot com bubble. Something was bound to turn and it may have been China’s entry into massive currency devaluation, which will handcuff the Fed from raising interest rates.
The US dollar (PowerShares DB US Dollar Bullish (NYSE:UUP)) looks like it has broken down from a head and shoulders top. Investors may begin factoring in QE4 the exact opposite of interest rate increases to protect from a massive deleveraging. The sectors hardest hit will be the ones most overvalued with high PE’s, debt and no earning.
The areas that may provide the greatest protection are the ones that have already been beaten down and are trading near liquidation values. The mining and metals sector may be one of the most undervalued sectors of all time and may see limited downside. Unlimited debt can only boost an economy for so long. Eventually, these bubbles burst, as we may be currently witnessing as the Dow showed its biggest one day decline ever.
Don’t be surprised to see some attempts to revive this market; however, such volatility, as we have witnessed, usually takes a long time to digest. For years now, it looked as if Central Banks solved the world’s problems, but we may see the reality that it was propped up by easy money. These current currency wars could be followed by trade and commodity conflicts where governments look to take control of strategic assets. Global markets were rocked by currency devaluations, which could lead to soaring interest rates and a US bond market (iShares 20+ Year Treasury Bond (NYSE:TLT)) crash.
Capital preservation is critical in times like this, and once again, we look for the ultimate safe havens in metals and mining trading at record discount valuations. Real assets backed by wealth in the earth may be the place to be as overbought markets fueled by easy money go bust. Learn from the history of civilization, where gold has always maintained its value as currencies crumble. Be careful of gold-backed ETFs such as SPDR Gold Shares (NYSE:GLD) and iShares Silver (NYSE:SLV). I believe in looking for the best junior mining assets controlled in safe jurisdictions by reliable management teams. This is the area where we can once again see tenfold gains.
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