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How the Market Works

Dead Gold Bugs

Posted by kdadmin on August 6th, 2015.

Dead Gold Bugs

Now that we’ve dumped our bond holdings and are sitting in cash, I’m regularly asked the question, “Should we be buy gold? You know, as a hedge?” The funny thing about hedges is that you need to know which way the hedge works.

Take the chart above. Notice anything? How about:

  1. As the Federal Reserve pumped money into the economy with its QE program, the price of gold shot up.
  2. Right about where gold started to drop in price, SPY (S&P 500 ETF) started to skyrocket, along with a continued QE program.
  3. The price of gold has fallen with both a rising SPY and with a terminated QE program.

What can we learn from this?

  1. The QE program devalued the dollar and drove the price of gold up in an uncertain economic cycle.
  2. As soon as the economy started to perk up (2012-ish), gold investors switched to the stock market in search of higher returns. Driving the price of the stock market up and gold down.
  3. The price of gold will likely to continue to fall; more directly as a function of a strong US economy.
  4. Should the stock market have a correction (10%+ drop), gold could enjoy a slight, albeit likely a short term resurgence, because of the strength of the US economy.

So, what does this mean to you?

  1. As the Federal Reserve removes money from the economy through higher interest rates, there will be fewer dollars available, driving the value of the dollar higher (against gold). Since gold is denominated in dollars, that means a dropping gold price.
  2. Since the US economy is stronger that it has been in years, the dollar becomes more valuable against other currency hedges (i.e. gold).
  3. A strong US economy doesn’t always mean a rising stock market. This is how the market works.
  4. Don’t buy gold.

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