Getting a clear view on the gold price ain’t easy. Too many influences! No one can predict the timing of the kind of events that send investors scuttling to their safe havens. By their very nature assassinations, terrorist attacks, major bank collapses, and other horrors are unpredictable. Yet in one area there is a useful signal. Isabel and I have just discovered the index nicknamed "The Investor Fear Gauge".
What’s this? The Investor Fear Gauge is the Chicago Board Options Exchange volatility measure — the VIX. Formally it is known as the CboE VIX — that’s its symbol. The VIX is designed to rise when US equity investors are feeling financial stress. It lessens as these investors get more relaxed and stop worrying.
Why is it helpful? Stressed investors flee a falling dollar and dollar denominated securities — bonds and shares. Their favourite refuge is gold.
VIX is bale to reflect investors’ fear because of its base. Its underlying securities are a wide range of options on the major US equity index — the S&P 500. It measures the price swings on the options as investors trade in and out. So, it reflects investors’ best prediction of near term risk.
The latest gold study from the VM Group, in conjunction with Fortis Bank, points to the importance of the VIX. It says that looking at the charts the relationship between the VIX and share prices has a long track record. This has repeatedly shown itself in bull and bear cycles.
The VIX shoots up on market turmoil
When the US stock market is in turmoil the VIX shoots up. This is because fund managers and investors rush to cover their risks by buying "put" options on their shares. This gives them the right to sell. Thus they gain insurance against further falls in their portfolios. When the market is bullish there is little need to buy puts.
For example, at the end of November the gold price retreated. This coincided with a fall in the CboE VIX. It went from 29 to just below 23.
Equity markets put in an impressive rally. The S&P 500 gained 5% in the last week of November. (The FTSE 100 and the Nikkei rallied by 4%.) Behind this recovery were rising confidence and falling fear. There was hope of another cut in US interest rates. That would give a quick boost to the economy and a fix for shares.
Donald Kohn, the Vice-Chairman of the Federal Reserve, had strongly suggested that there would be a cut in December. On the day, in fact, Fed chief Dr. Bernanke took a neutral stance on the prognosis. There was to be no change. But the markets were prepared to take his comments as an indication that a cut might well be in the offing.
Investors got even more relaxed in the run-up to Christmas. Gold was consolidating, trading in a narrow range not far from $810 in the week before. Option trading was pretty relaxed because of signs that the credit crisis could be easing.
The news was all upbeat. The Wall Street Journal reported that Merrill Lynch could get a $5 billion capital injection from Singapore’s Temasek Holdings. Stocks were expected to continue to rise. And anyway, the equity markets were only going to be open for half of the next couple of weeks.
Since the volatility indexes are forward-looking, they were reflecting anticipation for less put option in the short-term. A few good results and the VIX went below 20. In fact, it went down to 18.47. This was the lowest since early in October.
Its sister index, the CBOE NASDAQ 100 Volatility Index. VXN also fell similarly. VXN measures projected volatility in the technology sector.
Good, but not the only steer for gold
So, instead of pouring over mass of statistics, Isabel and I will be taking a look at the VIX as a quick way of checking one front at least — US stock markets’ funk factor.
Good it may be, but, we’d better remember that VIX should not be seen as THE steer on gold. US stocks markets are an important, but not the only factor for gold. Take investors expectations of falling US interest rates. They’ve good reason. The dollar and the US economy are being forecast to be the main guide to gold’s price trend in 2008.
2008 is an election year. The White House will do anything to stop the US going into recession. The Fed will be under pressure to bring in much lower US interest rates. Perhaps take them down to 3%, even.
This is a scenario where gold should win all round. Sharply lower interest rates may boost shares, but they will weaken the dollar. So this should bring buyers for gold. If there is a recession, that, too, will weaken the dollar and investors will decamp to gold.
2008 could be one gold’s most volatile years
Yet gold’s path next year could be far from smooth, according to the VM Group study. Gold is likely to see a lot of that volatility, it says. In fact, 2008 could be one of the most volatile years for gold for some time.
Gold’s fundamental supply/demand position is a very bullish one. A small production surplus of 123 tonnes is expected. That is equivalent to just less than two weeks' projected consumption and investment demand.
Such a narrow margin means the price will be susceptible to swings. It will be vulnerable to any story affecting likely supply or demand — central banks sales, jewellery demand, mine shut-downs, a worsening of the credit squeeze, wars, threats of recessions or political crises.
Plus, flight from shares has vastly increased fund and speculator participation in gold markets. They’ve come bringing a large armoury of financial market trading tactics, rumour mongering and other tricks. What they love is roller-coaster markets. The more volatility the greater the number of trading opportunities, say they.
So, it is going to be a hectic year.
Keep trading.
Erin and Isabel
