by John Galt
June 8, 2012 05:30 ET
On my radio program of June 6, 2012 I pointed out how gold has been leading the equity markets. In this commentary, I shall show how the two divergences from 2007 to this year will end and result in a short term collapse in stock prices. First, let’s review the chart of the S&P 500 versus the GLD ETF from 2007 to June 7, 2012:
The initial divergence as highlighted in the chart above shows that gold and equities had a wide spread with no indication of economic problems and the proverbial “risk on” trade that was initiated by the Federal Reserve under Alan Greenspan could continue for some time. There was no reason to invest in gold as the economic perception was that there was not a detectable economic emergency or crisis. That false perception changed after the collapse started in February 2007 as gold climbed sharply only to end the divergence in the summer of 2008 where everything started to collapse. After the reflation trade of 2009 began with the Fed’s QE1, the GLD (aka gold) led the S&P 500 until the summer of 2011 where the second major break in the chart pattern occurred. This break was due to the Federal Reserve’s half measure known as “Operation Twist” where as gold was predicting a massive Quantitative Easing program which never happened.
The second chart puts the past year’s events into sharper focus:
The chart illustrates with the two blue and red arrows the synergy between gold and equities moving in tandem until the break last summer. After the perceived failure to reflate an economy that would deteriorate in the future was realized, the circled portion of the chart indicates the double top in the GLD/Gold which has been in a long term decline since last summer. Meanwhile equities diverged from the move in gold and rallied one more time in 2012 as the markets have been given a Pavlovian like reaction to believe that the Fed would bail out everyone regardless of the economic consequences.
Gold however has warned that this is not the case. When you analyze the year long bear market in gold prices it becomes apparent that this consolidation has one more major move to the down side and support in the GLD is between 124-128, in the physical gold between $1260 to $1360 per ounce. While it is this author’s opinion that when gold bottoms that will indicate that the intermediate term bottom in equities is forthcoming with support for the S&P 500 around the 990-1006 area. If it breaks that support area, it probably means gold has at least temporarily broken the long term support of $1280 per ounce but the reaction of such a massive correction will be met by a panic response from the world’s central bankers. The schism between stocks and gold is in the process of ending now and as I warned on May 6th, the signal gold is sending is loud and clear with short term deflation and more deleveraging in the cards. As this split ends and markets turn one more time to the upside following gold’s lead, look for both markets to move in a parabolic fashion with the S&P 500 topping the 1800 level easily as gold breaks above $2900 per ounce.