The Daily Market Report: “Disorderly Unwind” of Market Complacency Would Lift Gold

USAGOLD/Peter Grant/07-07-17

Jonathan and I had a water-cooler conversation early in the week, trying to figure out why the gold market’s reaction has been subdued in light of what we perceive to be the considerable and mounting risks. Secondarily, why the Fed continues to foment optimism that is very clearly not reflected in recent data. And more important, why anyone still believes them!

When the Fed succeeded in pulling us back from the brink of economic catastrophe during the financial crisis, it set the stage for the growing level of complacency that has emerged over the past 5-years. They saved our collective bacon once, they can certainly do it again. Can’t they?

Keep buying those bubbly stocks, regardless of the underlying fundamentals, comforted by an expectation that the Fed will ride to the rescue if they ever come under serious pressure. Meanwhile, the Fed continues to tighten policy in an effort let some of the air out of that bubble.

The Fed is treating the symptoms, rather than addressing the underlying disease (which is arguably debt). The tightening campaign suggests that the Fed remains confident that the economy is gaining momentum and recent weakness in the inflation data is transitory. If the flattening yield curve is suggestive of an impending recession, ramp up the balance sheet normalization talk to get the rates at the long-end higher. If gains in gold are signaling there may be a problem, knock it down.

Remain calm. Remain complacent. All is well. There is no risk of another financial crisis in our lifetimes! Go about your business . . .

In their monetary policy report to Congress, the Fed acknowledged that “Valuation pressures across a range of assets and several indicators of investor risk appetite have increased further.” They classified the vulnerabilities to the U.S. financial system as moderate. That however is a far site more vulnerable than the zero risk in our lifetime seen by Janet Yellen.

Ahhhhh, peaceful . . . with no volatility. Nothing to do but kick-back and watch that equity portfolio appreciate.

And yet, the warnings keep rolling in. It’s not just from Dr. Doom either. The likes of David Stockman, Jim Rickards, Albert Edwards, John Mauldin, among others have all said that the current situation is simply not sustainable. Nonetheless, markets continue to display historically high levels of complacency.

Deutsche Bank went so far as to suggest the market flat-out broke in 2012 as volatility measured by VIX and their measure of market complacency (EPU index) diverged starkly. This is an inherently unnatural, and therefore unstable situation.

Note that up until 2012, VIX and EPU were closely correlated. After that, something broke and markets began to grossly under-price risk.

Endemic complacency, which continues to take hold of the markets, is likely to play an increasingly adverse role the longer markets continue to operate as they recently have. However, although volatility remains depressed, the risk continues to be pushed to the tails. This is a buildup of metastablity. The longer the stick remains still, the more surely it will fall. – Deutsche Bank’s Aleksandar Kocic

When that stick falls — when VIX and EPU revert to their means — risk assets like stocks will tumble. Meanwhile, safe-haven assets like gold will surge in value.

Kocic likens the situation to driving a car with malfunctioning warning lights. The engine is burning up and is going to explode as the driver tools merrily along with no indication of an impending disaster. Gold is one of those warning lights.

Kocic warns that the “risk of disorderly unwind is growing.” Don’t be complacent! Now is the time to start building your hedge. Take a portion of your stock market gains off the table and move them into the safest of the safe-havens.

[I will be out of the office July 10-12, so the DMR will be on a brief hiatus]

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