On Thursday, January 23, the Dow sank over 175 points,
losing more than 1% on the day.
While it was a bad day for the overall stock market, it was a good day
for bonds and gold.
The 10-year yield went down to 2.77%, meaning bond prices
went up. Meanwhile, gold went up
almost 2% to go over the $1,260 per ounce level.
Stocks were supposedly down because of fears over a slowing
economy in China. But while that
news is interesting, I would like to focus on bonds and gold.
It is noteworthy that they are moving somewhat in
tandem. This has not always
historically been the case. In the
1970’s, during a period of increasing inflation, gold performed well and bonds
performed poorly with increasing interest rates.
In the 1980’s, things switched up. As inflation fears faded, gold went down
and interest rates also went down, driving bond prices up.
It has only been in the 21st century that the two
have been more highly correlated.
Gold finally started to do well again at the turn of the century, after
having been a terrible investment for the previous 20 years.
Meanwhile, bonds continued to do well, as interest rates
went to historic lows. While bonds
have not done as well as gold over the last 12 to 14 years, they have still
been a decent holding.
As stocks went down on Thursday, investors turned to both
bonds and gold. One thing that the
two investments have in common is that they are both sought after for
safety. When investors are
fearful, they will tend to go to one or the other.
The difference is that fearful investors will turn to gold
when the fear is inflation.
Investors will turn to bonds for safety when the fear is recession,
depression, or deflation.
While Thursday’s market in no way makes a trend, what if
investors continue to sell stocks?
Where will they go?
Right now, it looks as if they may be undecided. Perhaps a better way of stating it is
that different investors are fearful of different scenarios. The people buying gold are worried
about more Fed inflation and a depreciating currency. People buying bonds are worried about another major downturn
in the economy.
We don’t know which ones will turn out to be right. Maybe both bonds and gold will continue
to do well. Or maybe Thursday was
a trick and we will see stocks regain their footing and eventually surge to new
highs.
2014 could be an interesting year. The Fed has created quite a mess with all of its so-called
quantitative easing, which is nothing more than creating money out of thin air.
If the economy hits another major downturn, will we see the
1970’s again with rising inflation and rising interest rates? Or will we see 2008 again with a major
recession and relatively low price inflation and low interest rates?
If stocks do poorly in 2014, it will be interesting to see
who wins the battle for the money looking for safety. Will it be the bond buyers or the gold buyers? Maybe it will be both, at least in the
short run.
UPDATE: As an additional note, this post was first written on Thursday night. Following that, on Friday, January 24, the stock market tumbled even more. Bonds were up again and gold was up slightly.