Jordan Roy-Byrne, CMT | Oct 04, 2013 12:39PM ET
We’ve discussed the negative correlation between precious metals and the stock market. It has now been in place for over two years. Since September 2, 2011, the HUI Gold Bugs Index is down 64% while the S&P 500 has gained 43%. Silver has lost 48% while Gold has shed 28%. It’s not exactly groundbreaking analysis to say that a decline in the general market would be good for precious metals. After all, it’s happened in the past which includes various times in the 1970s as well as the Y2K tech bust. Given the scope of the decline in precious metals, some generalist or mainstream money needs to come in for the sector to sustain a rebound. That money will only dip into precious metals once the general market struggles.
Precious metals are a niche and a niche of the market that is often ignored. When conventional investments do well, there is no need for alternatives like Gold. However, when conventional investments don’t perform or perform poorly, it facilitates growing interest in alternatives like Gold. This is why the two markets are often negatively correlated. History shows that declines in Gold often end when the stock market peaks.
The chart below plots Gold and the S&P 500 from 1970 to 1980. The S&P 500 experienced two bear markets. The first began at the tail end of 1972, which was well after Gold began its bull run. Yet, Gold ran from roughly $60/oz to $200/oz which coincided with the bottom in the S&P 500. When the S&P 500 peaked in 1976, Gold’s nasty decline ended and it gained nearly eight-fold in the next four years.
Though most (and us included) have been surprised by the duration of the equity bull market, there are a couple of reasons why I think its just about as its end. First, fund flows into equities have surged in recent months and recently hit records on various scales. The chart below shows that weekly fund flows hit a record.
Furthermore, sentimentrader.com recently reported that fund flows into equities, based on a rolling nine-month scale hit an all-time high. The reason the record fund flows are a strong bearish signal is because they are occurring more than four years into bull market. Where will the additional buying power come from? It won’t come from short covering, which is now at a record low!
Interestingly, more than a few mining companies told me that at the recent Denver Gold show, one of the most respected and prestigious industry events there were some generalist fund managers. While the gold bug funds lick their wounds and retreat, in come the mainstream and generalist funds to pick up the bargains of a lifetime. Once this bottoming process moves to its final stages, many stocks will be primed for spectacular rebounds that could occur in weeks and months. Readers are advised to watch closely and spot the companies which show the most strength during this retest.
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