Overseas trading last night indicated a significant selloff in global equities was coming. This morning’s opening confirmed this, as the DOW toppled by more than 430 points, settling near session lows at 10,700. Oil and base metals also sold off, with both sectors dropping by nearly 5%. Gold corrected down to $1730, where strong technical support was found.
The panic this morning is due to several converging factors which followed yesterday’s action by the Fed. First, news out of Europe indicates a significant deterioration in the Greek situation. Though the embattled nation announced an acceleration of budget cuts to sustain bailout payments, it has not been enough to stop the cost of insuring Greek debt from continuing to rise.
Next, news came out of China this morning that manufacturing is down for a third month in a row, signaling a chill in demand from the west. China has been one of the few bright spots in the global economy, and this drop in production has investors worried that the interdependence between the east and west could downshift Chinese growth.
Though jobless claims fell last month in the US, it is not being seen as a strong indicator of a directional shift here at home. This combined with concerns over Europe and China has been enough to trigger panicked selling across the globe.
What’s astounding about the sell-off in this particular trading session is that it follows on the heels of yesterday’s Fed announcement. In an attempt to spur growth, the Fed plans on swapping short maturities for longer ones within their US debt portfolio. The idea behind this was to keep interest rates and borrowing costs at near zero for an even longer period of time. In theory, this would spur growth by encouraging investors to leave money on the table and re-invest in the fledgling economy. This morning’s sell-off has sent a clear message that the market does not believe this latest action from the Fed will have any positive effect. Much of the selloff in gold this morning is being blamed on margin call liquidations. Often times a major downward move in equities causes traders to sell gold in order to raise cash and meet margin calls on other positions. Though these corrections can be severe (as is the case this morning), they don’t tend to last.
From here, one of two things is likely to happen. Either the Fed will institute another round of quantitative easing, or the economy will likely slip back into recession. If QE3 is the next play, there is no doubt that gold will benefit in a big way. Another round of cash injections would be extremely damaging to the dollar, and we would expect gold to move quickly to the upside. If instead they do not act and the economy falls back into recession, we would expect gold to assume a strong position due to a lack of other viable investment vehicles.
If this summer’s trading history is any guide, there is a strong chance that this correction is reactionary in nature and does not represent any fundamental mid or long term change in the market direction. If that’s the case, today’s levels present the best buying opportunity we have seen since early January. As several major banks have now come out with predictions placing gold over $2000 by year end, this may be one of the last chances to place purchases at more than 15% below that level. That said, most people these days would trade the good returns for a little peace of mind, knowing that they’ve done something to stop the bleeding within their portfolios. In the end, that’s the real reason gold is likely to be a popular play over the next few months.