Now that the fiscal cliff is temporarily resolved, will it have a buoyant effect on the stock market? The first trading day of the year answered that question for some when the Dow Jones Industrials (DJI) surged 308 points. I don't associate specific news events with actions in the stock market. Contrary to what many believe, there is not a strong correlation between specific news events and stock market action. One specific instance which comes to mind is what I termed the "Bin Laden" high of May 2011. Immediately following his assassination, the stock market made a range between 12,800 and 10,400 on the downside. Normally, market pundits would attribute the face of terror's demise with a positive outcome in the stock market - just the opposite happened. So despite people dancing in front of the White House, the stock market had a bad summer of 2011.
Is the fiscal cliff agreement different? While the first three trading days of 2013 saw a delirious market go up by more than 300 points (the great majority on the first day), I was watching another market that has in the last few years been more closely correlated, gold. Both markets are affected by excessive credit creation transforming into speculation. During the economic crisis of 2008, what do you think happened to gold? Did it go up or down? Let's not forget gold is often touted as a crisis hedge, and that period certainly was one of crisis. In fact gold went down for much of 2008. So did its complementary metal, silver. Recall also that crude oil (remember peak oil?) absolutely crashed in 2008. The wisdom of "conventional" thought tends to dissipate very quickly during times of panic.
My first slide illustrates the strong correlation between gold and silver for 2012. Again, consider that these markets have both industrial and speculative demand. Speculative activity is not a bad thing despite speculators often being blamed for some market ill. Speculation provides liquidity to a market. When the DJI spiked on 1/2/13, I watched gold to observe its action. While gold did increase, the rise was rather tepid. The action on the following two trading days belied what was occurring in the DJI - gold went down and rather strongly. Gold's lackluster performance on 1/3 and 1/4 is a harbinger of further stock market weakness. Silver has been a much weaker performer with its last major high coming in with the "Bin Laden" DJI high of 2011. Silver and gold do not move in opposition. Given silver's last major high in 2011 and gold's later in the same year, we witness some of the earlier speculation waning.
The second slide in the presentation illustrates the relationship between gold and the DJI since the stock market's last major low in 2009. Both markets have trended in the same direction though as I stated earlier, gold made its high in 2011. If gold has in fact made its final high, expect the DJI to begin its descent. Given the relationship between these markets, this is a fair conclusion.
The doomsday effect of the fiscal cliff is in the rear view mirror for now. The negative undercurrent of popular sentiment, however, will surface in the stock market. That sentiment has already been felt in what was supposed to be an explosive market, crude oil. It appears to have crystallized in silver and to a lesser extent gold. The stock market will also be affected by this mood and when it does, the economy will follow.
Markets go up because people want to buy them. For the generational period of 1982 to 2007, there was a lot of buying going on. The economic crisis dampened this enthusiasm, as speculative booms turn to bust. Conversely markets go down when people want to sell. We witnessed this in 2008 and we will see such action again with more ferocity.
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis.
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