There was complete panic as stock markets melted down on Monday, but on Tuesday, it was as if everything was fine. So, was it just an overreaction to a few isolated factors? Or was it a premonition? On this episode of the Money Metals' Midweek Memo, host Mike Maharrey dissects the big selloff in both stocks and gold. What caused it? What happened to gold being a safe haven? And what can we expect next from the Federal Reserve?
There was carnage in the markets on Monday (Aug.5). Stocks sold off, with several major U.S. indexes falling more than 3 percent.
Mike opens his show with an analogy.
"You know how sometimes you’re driving on the interstate and you get really sleepy. You know, you’re doing the old head bob. And then all of a sudden, you find yourself swerving off the road and you hit those rumble strips. Brrrrrrrrp. That’ll wake you up, right? You get this big surge of adrenaline and think, “Man, I about died.” For a while, you’re wide awake and attentive to every detail. Then you just kind of forget about it. It’s almost like you weren’t in any danger at all. I think the markets just played out this kind of scenario on Monday. Investors swerved and hit those rumble strips. It was a total freakout. But on Tuesday, it was like, no biggie. Everything is fine."
Mike provides some highlights (or lowlights) of the big selloff, noting that it wasn't limited to U.S. markets.
"It just goes to show how quickly market sentiment can shift."
Mike gives an overview of two big factors that he thinks served as catalysts for the selloff.
First, the Bank of Japan hiked rates the previous week. It was only the second hike by the BoJ since 2007. The rate hike gave the yen a big boost and that created a problem.
"I talk a lot about how central bank monetary policy creates malinvestments. It’s about incentives, right? When policymakers intervene in the markets, it creates incentives to do certain things. Some of these incentives are purposeful. For instance, low interest rates are meant to incentivize borrowing in order to stimulate economic activity. ... Then there are the unintentional incentives. Japan’s absurd interest rate policy incentivized a huge number of carry trades."
Mike explains what carry trades are and how they can impact the global market.
The second factor in the selloff was the worse-than-expected July jobs report.
"And with that, everybody decided there was a recession risk. It’s like somebody shined a light in the crawlspace and discovered the foundation of this economy was rotten! They fretted that the Federal Reserve waited too long to cut interest rates and worried its lallygagging would tip the economy into a recession.
"It’s amazing how fast everybody went from being certain we were on the path for a soft landing to bracing for a crash landing!"
Mike noted that a lot of people have asked him why gold - supposedly a safe haven asset - sold off along with stocks. He goes on to explain this is quite common and why.
"Investors often liquidate winning gold positions during a sharp downturn to cover stock losses. But gold generally falls less sharply and recovers more quickly – exactly the scenario that played out on Monday."
Mike also notes that the dip in gold needs to be kept in perspective.
"Even with the downturn, gold hit a record just a few weeks ago, and the yellow metal is still up well over 15 percent on the year with bullish factors firmly in place...
"Whether Monday’s selloff was just a tremor before the earthquake, or the beginning of the great unwind, there are plenty of reasons to be bullish on both gold and silver."
Mike says that whether the selloff was just an overreaction or if it was a harbinger of things to come remains to be seen, but he thinks the quick recovery should be taken with a grain of salt. That's because all of the factors that could take down the markets and the broader economy are still in place.
"The economy is still loaded up with debt. All of the malinvestments incentivized after 2008 and the pandemic are still out there. The economy is still addicted to easy money (inflation). The Fed is still between a rock and a hard place. Everything is still in place for the inevitable bust. It appears this wasn't it. Perhaps it was just a correction. Perhaps it was a tremor before the earthquake. But I'd be wary of getting all cocky and buying into the 'everything is fine' narrative that still prevails in the mainstream."
Mike then pivots to talk about the problem facing the Federal Reserve. He likens the central bank to a drug dealer and the economy to an addict hooked on easy money.
"The U.S. economy is addicted to easy money, and it needs more and more of this drug to maintain the high. The problem with this scenario is eventually the addict overdoses."
Mike provides a history lesson, giving a quick overview of Fed actions from the 2008 financial crisis to today.
"This rate history lesson illustrates a point. The economy needs more and more easy money every single cycle. The threshold for 'normal' gets lower and lower – meaning more and more of the easy money drug. That’s why everybody is clamoring for rate cuts today. The addict is on the verge of withdrawal. He wants his drug supply to go back to normal – the new normal."
Mike points out that from a historical perspective, rates are closer to "normal" today than they were in the zero percent era.
"A chart of the trajectory of the federal funds rate over time makes it clear what’s happening. Every cycle, the Fed delivers more of the easy money drug fueling a boom. And once the bust passes, the peak interest rate in the next cycle ratchets lower and lower. As the addict builds up resistance to the drug, it needs more and more to maintain the high and can tolerate less of a taper when the party gets out of control."
Of course, constantly upping the dosage of a drug to keep the addict high creates another problem - overdose.
"This is called being stuck between a rock and a hard place. The Fed can ramp up the party and risk an overdose (in the form of more rampant price inflation) or it can hold back the drugs and risk a painful withdrawal. Either way, the addict has a problem."
Mike argues that the recent stock market hiccup shows what happens when the addict starts feeling the effect of withdrawals.
"And we already know what happens when the dealer starts pushing more drugs – which is exactly what the Fed is likely to do when the bottom really does fall out of the economy. But for now, I guess we can all keep pretending it’s all fine."
Mike notes that selloffs in gold and silver present an opportunity to buy, and he issues a call to action - call 800-800-1865 and talk to a Money Metals' precious metals specialist.
"Don't try to get your insurance after the crisis has already hit!"
About the Author
Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
