Bottom for both gold and bonds?
By Mark Hulbert, MarketWatch
Last Update: 12:21 AM ET April 22, 2005
E-mail it / Print / Discuss / Alert / Reprint /
ANNANDALE, Va. (MarketWatch) -- An extraordinary thing happened earlier this month among the gold and bond market timing newsletters monitored by the Hulbert Financial Digest.
The average adviser in both camps became extremely bearish.
On the contrarian grounds that the markets rarely accommodate the majority, this should be bullish for both gold and bonds.
But how could that be? Gold is an inflation hedge, after all, and it typically performs the best when inflation is accelerating. Such an environment would be deadly for bonds.
One response to this apparent paradox, of course, might be to remind us that contrarian analysis is neither perfect nor has pinpoint accuracy. And that is no doubt true.
You might be especially inclined to dismiss contrarian analysis right now, given Thursday's encouraging economic news and the ($INDU: news, chart, profile) Dow Industrials Average's remarkable rally.
But, for this column, I want to take the contrarian interpretation seriously. Does it really have to involve a contradiction? Are there realistic scenarios in which both gold and bonds will perform well together?
One reason I don't want to cavalierly dismiss the contrarian interpretation: The current sentiment situation is quite rare. Take a look at the accompanying chart, which plots bond and gold newsletter sentiment over the past few years. Notice that gold and bond sentiment typically move in opposite directions, with one hitting a high at a time when the other is hitting a low.
The chart is based on the Hulbert Gold Newsletter Sentiment Index (HGNSI) and Hulbert Bond Newsletter Sentiment Index (HBNSI), which measure the average exposure to the gold or bond markets among a subset of short-term market timing newsletters followed by the HFD. Negative values indicate that the average timer is advocating being short the market.
Prior to the last month, the lowest reading on the HBNSI over the past decade was negative 56.3 percent. That already represented extreme bearishness, of course, and often was registered at or close to bond market lows. But on April 5, the HBNSI broke to an even lower level: negative 67.4 percent.
A broadly similar story can be told about gold market sentiment, though gold sentiment hasn't actually broken down to new lows. It merely has come down to more or less match previous record lows. (The record low for the HGNSI is negative 31.3 percent; on April 14, this gold sentiment index dropped to negative 30.4 percent -- just 0.9 percentage points above the all-time low.)
If we take seriously the contrarian analysis of these two sentiment indexes, what might they be saying about the future? The most straightforward interpretation, it seems to me, is that a crisis is imminent in which the viability of the financial markets is called into question -- one in which there is a flight to quality (such as government bonds) as well to hard assets (such as gold).
This isn't as far-fetched as it may sound, scary as it otherwise is. It is a scenario to which Richard Russell, editor of the Dow Theory Letters, has been giving serious credence for a number of months. Needless to say, Russell is not part of the bearish consensus that currently prevails in either the gold or bond arenas.
As Russell sees it, the world financial system currently is so precarious that the monetary authorities must "inflate or die." And even if those authorities do inflate, as they show every sign of doing aggressively, Russell says it is not at all clear that they will succeed.
The "die" option in the "inflate or die" trade-off, of course, is a deflationary collapse. Bonds would do well if that were to happen, needless to say. But it is not out of the question that gold would too, if in that collapse investors lose enough confidence in the monetary system.
Unfortunately for those of you who would rather not contemplate such a scenario, Russell can't be dismissed as a Chicken Little-like adviser perennially saying that the sky is falling. His stock market timing performance over the past 25 years is one of the best of any of the newsletters monitored by the Hulbert Financial Digest.
Furthermore, Russell's warnings were echoed recently by what would otherwise appear to be an unlikely source: Former Federal Reserve chairman Paul Volcker. In an op-ed piece for the April 8 edition of the Washington Post, Volcker wrote that "under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it."
So those who dismiss the contrarian interpretation of the gold and bond sentiment data may be doing so at their peril.
News 
Market Data 
Discover 
