What Might the End of the Stock Market Rally Mean for Precious Metals?
Global equity markets have been on a tear in recent years, with the benchmark U.S. SP 500 index having made solid triple digit returns over the span of the last several years. Markets have been climbing since the 2009 lows, and continue to make new all-time highs.
This run higher in the equity markets as well as current valuation levels obviously begs a few questions:
-Will the rally continue?
-Are stocks overpriced at current levels?
-Is this a set up for a nasty correction?
-What has driven such significant upside?
We feel it is important to address some of these questions, as we believe the day will come when equity investors once again run for the exits. In turn, we believe that gold and precious metals could stand to benefit handsomely if and when this does in fact occur.
The stock rally is now in its seventh year. To put this into perspective, the average bull market lasts five years. Stocks have seemingly risen non-stop over the last half-decade, and new all time highs have been discussed widely in financial media circles.
We believe, however, that what goes up often comes down. Given the extent of the rally, many of the economic problems that still exist and the underlying factors driving the rally, we believe it is only a matter of time before this rally has run its course.
With regards to stocks being overvalued at current levels, once could certainly make the argument that equities have become expensive. To shed some light on this subject, let’s look at current price-to-earnings ratios, both trailing and forward.
The current 12 month trailing P/E ratio for the SP 500 is a tad over 19. The historical average for this number is 15.5. The forward P/E ratio for the SP is currently at 17, while the average over the last decade has been 13.5.
While simply looking at this data can be deceiving and may not give one the true lay of the land, it does indicate that perhaps stocks have become rich. Adding some credibility to this notion is the fact that stocks have not undergone a true correction in some time. In fact, stocks have not entered “correction” territory (defined as a 10 percent drop) since 2011.
While we cannot see the future, we do believe that stocks will not continue higher indefinitely. We believe it is only a matter of time before stocks reverse course.
Stock markets could, in fact, be setting up for a large reversal-a reversal that may catch many off-guard-that could begin to take shape anytime now…
We feel it is important to understand what has driven the rally to put this into context. The U.S. and many other countries have taken significant measures in order to try to boost economic activity. Quantitative easing as well as extremely low interest rates have been used in an attempt to fuel economic output. While some would argue that these measures have proven effective, others would say that significant problems still exist, and that the rally has been “artificial.”
Perhaps we are close to finding out…
The U.S. is nearing its first interest rate hike in years. The Federal Reserve appears to be on track for an initial hike of 25 basis points in the coming months-perhaps as soon as July or September.
Once the Fed does act, stocks may begin to falter. As the era of free money comes to a close, it may send investors looking elsewhere. Many who have ridden large portions of the multi-year rally may be the first to cash out.
Once capital begins to flow out of the equity markets, investors will likely be looking for alternative places to put cash to work. Alternative assets like gold and silver could potentially see a massive influx of investment capital.
While gold has been trending lower during this period of higher stocks, we expect the inverse correlation of gold to stocks to hold true.
The gold market does appear to be in the basing process when looking at recent price action, and investors have been buying the yellow metal on dips. The market does not appear to be headed lower, and we suspect that once capital starts flowing out of stocks, the gold market may once again turn higher.
In fact, we believe that gold will resume its long-term uptrend, and that now could represent one of the most opportune times to buy gold.
As the stock market approaches its eventual top, now is the time to be considering alternative asset classes for diversification. Gold has stood the test of time as a reliable store of value in good times and in bad, and we believe may provide an excellent investment opportunity at current levels for the long-term investor.