In 20/20 hindsight, Sell in May was a pretty good idea. Sell in April might have been even better but that is not how the old saying goes. Gold has just moved past the $1200 mark and billionaire investors are back in the news telling you that Gold is the only sensible investment. Should you listen? Of course. Should you buy? Only in our Commodity ETF portfolio does GLD rate highly. In the other portfolios that include GLD, the ETF ranks in the middle of the pack with its trusty sidekick SLV. That means the System is telling us that there are better places to put our money right now. How can that be with such a beautiful chart? Because, if you look closely, you will see that the scale is very large both in terms of time and price. It masks some serious monthly volatility that regularly reaches into the 20% zone. Gold may be as good an investment as people like Mr. Kaplan say but be prepared for a wild ride and you should probably wait for the next downward lurch to buy in.

Price of Gold in US$ per ounce

What has changed over the last few weeks?

The biggest change in the global financial landscape is the nearly US$1 trillion European Rescue. While property investors as far away as China hoped that some of the new liquidity would somehow eventually slosh into distant emerging markets, the package’s announcement appears to have pushed excess liquidity to the sidelines instead.

In the short term, the “Flash Crash” scared well over US$10 billion out of US equity markets as seen in the latest statistics from the Investment Company Institute report (click chart to see report).

US Mutual Fund Flows

Usually, it is not all that helpful to look backwards. Historians are not normally known as the best investors. But in this case, these two events will help us gauge the overall investment background so that we can rate the impact of both positive and negative surprises.

  1. Government Intervention yields diminishing returns
    Whether one agrees or disagrees politically, the last two years have been all about Government Intervention. But that is starting to change. When the US Congress passed TARP the second time around, the conversation was apocalyptic in nature. Nearly all of the G20 countries jumped in with deficit and stimulus packages (BBC summary) and politicians and central bankers were applauded for staving off the Second Great Depression.
    This time, however, the conversation sounded more like the owner of an old car unhappily agreeing to a big repair job that cannot be put off any longer. The impact was muted as voters (who are also consumers and investors) recognized that the bailout was going to cost lots of real money while delivering very few tangible benefits.
  2. Investors are skittish
    The reaction to the “Flash Crash” of May 6th shows that investors are skittish, pure and simple. That is important as we look at the Fear and Greed chart which we talked about several weeks ago. Sentiment wise, we are still facing the “Wall of Worry” near the “Caution” marker.

The volatility we have seen this month has knocked down some of the scores in our System although they still remain positive. In addition to funds being scared to the sidelines on the back of the muddled Euro Rescue and the Flash Crash, there have been reliable reports of large short positions building up in the markets. On the other side of the equation, on Thursday and Friday of last week, the number of SPY ETF shares expanded by 5%, leading to speculation that the Plunge Protection Team might be active.

So what is the next surprise?

Markets move on surprises. Right now, investors are broadly positioned in anticipation of more negative news, so a negative surprise will have less impact than a similar positive surprise.

So, does that mean the next surprise will be positive? Certainly that is not the consensus view. For consensus, turn to an editorial for the Wall Street Journal in which PIMCOs CEO argues (in the third from last paragraph) that investors are still over-extended and over-leveraged. As part of Mr. El-Erian’s “New Normal Economy” hypothesis, investors are still not prepared to accept the newer, more subdued rates of return that we are likely to see in the future. This view of the world was radical when PIMCO popularized it in early 2009 but, after a year on the shelf, it has now become consensus and has been priced in to the markets.

So, we would argue that a negative surprise will have a relatively small negative impact on the market because the market is ready. A positive surprise on the other hand would likely have a more positive impact on the market than one would normally expect. We therefore will continue to implement the System recommendations on our various portfolios despite the setbacks in the past three weeks.

Filed under: ETFMarket Comment

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