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What Could Further Corrections
in Equities Hold for Precious Metals?

By Charles de Meester
Metals Focus

Equities have had a tough past few days. Market wobbles started early last week, following new all-time highs reached by both the DJIA and S&P 500 indices. Prices started trending down, until a mini-meltdown emerged towards the end of Monday’s trading session. That day alone, the two US indices suffered peak-to-trough losses of around 1,600 and 125 points respectively; on Tuesday, US equity markets opened yet lower. Nor was this limited to the US; round the world, most equity markets were in the red.

The correction in equities is arguably not surprising. After all, their prices have rallied relentlessly since they bottomed shortly after the Lehman crisis. At its recent peak, the S&P 500 had more than quadrupled from its post-crisis trough. Moreover, in the face of the US liquidation, contagion to other equity markets is also to be expected. The past couple of years have seen a broadly synchronised rally across most equity markets as well as bond and credit markets.

Lastly, it should be stressed that this is not the first sizeable correction during the past few years’ rallies. Indeed, with the exception of 2013, the S&P 500 has suffered corrections that saw it break below its 200-day moving average every year this decade. In our view, however, this time should be different. In contrast to what has been the case over the previous few years, market consensus is increasingly cautious towards equities.

Our own field research suggests that professional investors have had concerns towards equity valuations for some time now, but were loath to trade against such a strong trend. This has been a key headwind for gold and other precious metals investment demand during recent years. If this latest correction is interpreted as having set the cycle peak, a growing number of portfolio managers may decide (to some extent) to rotate away from equities, driving further losses.

What could all this hold for precious metals? On Monday, in the face of heavy equity price losses, gold’s safe haven attributes started to emerge, fuelling a $10 rally in the yellow metal. However, this proved to be short-lived and these gains were quickly given up. Looking ahead, in the immediate aftermath of any further corrections, we may see gold also suffer losses, as investors sell liquid assets across the board, to cover margins or to fund redemptions. Such pressure will no doubt also spread to other precious metals.

Further ahead, however, we believe that a possible end to the equity price rally would prove positive for gold investment and, by implication, also prices. As expectations of stock market gains become limited, we believe that investors will begin to look for other sectors to reinvest part of their portfolio. With bonds and credit also richly priced, less crowded markets, among then gold, could benefit from this. Indeed, the likelihood of an equity market correction has been the key assumption behind our constructive outlook for the gold price this year.

Such upside for the yellow metal would likely also fuel gains in silver and platinum. We would expect the former to potentially outperform gold. In part this reflects its traditional high-beta relationship with the yellow metal. Moreover, the global economic recovery that is underway should also eventually boost the appeal of silver’s industrial metal attributes. In contrast, platinum could struggle to keep up with gold, in the face of its own lacklustre fundamentals. Lastly, palladium, the best performer among major precious metals, should come under further pressure, given its traditional positive correlation with equity prices.

Editor’s Note: Charles de Meester is a founding partner of Metals Focus, one of the world’s leading precious metals consultancies,

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