Gold And The Middle Class Revolt

If the past two years could be described with a single word, it would have to be “uncertainty.”  Investors and non-investors alike have been dominated by this emotion, and its ubiquitous presence can be seen in the absence of a clearly-defined trend in the US broad market up until November.  This uncertainty has been most pronounced among those in the middle class.

This lack of confidence in the economic outlook among middle class wage earners has had an enormously outsized influence in the political realm.  The outcome of the 2016 presidential election is a case in point; the lack of money velocity is another.  Perhaps the biggest result of middle class uncertainty has been the directionless trend in the NYSE Composite Index (NYA), which reflects the overall market for U.S. equities.  Sustained, runaway-type rallies typically require widespread participation among retail investors, most of whom are middle class.

Middle class uncertainty can be seen in the organized protests all across the country this week.  Over the weekend the crowds in Washington, D.C. again made the news, only this time it wasn’t Trump’s inaugural crowd but a gathering of protestors.  A crowd of almost 500,000 gathered for the Women’s March on Washington to protest the Trump presidency.  Times of uncertainty breed hostility and revolt. 

The flip side of the spirit of uncertainty is that, unlike its much stronger cousin fear, it tends to be unfocused and aimless.  Witness for instance the Women’s March on Washington and the many smaller marches in cities throughout the country this weekend.  What exactly were these people protesting?  I’m not sure most of them even knew what they were doing on the streets, yet they felt compelled to go out and protest something -- anything.  Indeed, when the spirit of uncertainty is prevalent it breeds indecision in almost every aspect of life.  This is another facet of the directionless and range-bound market environment worth considering. 

My mentor, the late Bud Kress, emphasized that whenever his Grand Super Cycle of 120 years bottoms, it’s always accompanied or followed by revolution.  Prior to his death, Bud predicted that the 2014 Super Cycle bottom would witness an accelerated trend toward socialism in the U.S. government.  While there is some merit to his prediction, it’s probably closer to the truth to say that the revolution(s) that have happened in the last couple of years have been mass reactions against socialism in government.  One thing is for certainty, though: the spirit of revolt has been quite strong.

The insecurity and uncertainty prevalent among the middle class is also reflected in the following graph.  The Middle Class Index (MCI) show below is comprised of the companies which cater mainly to the middle class, including WalMart, Dollar General, McDonalds, Ford, and JC Penny.   

As you can see here, the MCI has traced out a sideways pattern since 2014 and in recent weeks has shown a modicum of weakness.  This sagging pattern over the past few weeks even as the major stock market indices approaching all-time highs is a little disconcerting.  Perhaps this explains the feelings of anger and revolt that have become commonplace of late.

Should the middle class index fail to break out from its 2+ year trading range soon, the middle class may show further signs of discontent this year – especially if President Trump fails to deliver on his promises to the middle class. 

Moreover, a failure of the upper-middle class index to reverse its downward trend fairly soon could potentially cause problems with the broader economy given their outsized impact on consumer spending. Needless to say, the next few months will be very informative on a number of levels.

With discontent clearly reaching the boiling point in the middle class, why hasn’t this been adequately reflected in the price of gold?  Although gold rose more than 9% in 2016, its first annual gain in four years, it finished the year well below summer high.  Gold’s weak finish to 2016 was largely due to the market tide expecting strength from the U.S. economy under the incoming Trump administration.  Investors expectations of higher interest rates and higher stock prices in 2017 triggered an unwinding of safe haven trades in both gold and government bonds in Q4, undermining the metal’s desirability for uncertain times.

More recently, however, gold has benefited from a technically oversold condition as well as signs of short-term weakness in the global equity market.  In late December, gold confirmed a bottom in relation to its 15-day moving average per the rules of our technical trading discipline.

Not everything was supportive for gold’s latest rally effort, though.  Also needed to confirm anything beyond a short-term rally is a reversal of gold’s relative strength indicator (versus equities), which remains near its low for the year. 

Uncertain times usually bode well for the gold price since the yellow metal is a prime haven for safety-minded investors.  Gold’s best performances, however, occur when outright fear is the dominant emotion among investors.  Uncertainty can serve as a supporting factor for gold prices, but by itself it’s unlikely to carry the gold price to substantial heights.  Something more meaningful is needed for that.  Gold is driven primarily by two major factors: sustained inflationary pressure or sustained deflationary pressure.  Anything that threatens to undermine U.S. dollar strength (e.g. the threat of military conflict or political uncertainty) would bode well for gold’s intermediate-term outlook.  Inflation, per se, isn’t needed to boost gold but a reversal of the dollar’s uptrend, even if only temporarily, would suffice.

The rally to date in gold and silver has been characterized by many analysts as simply a technical rally.  Short covering and seasonal/holiday-related buying were certainly key factors in the rally getting started. However, additional gains from here, provided they are accompanied by steady erosion in the dollar index and improvement in relative strength, could turn a technical rally into something more substantial.  In particular, a break below the 120-day moving average for the dollar index (see above chart) would markedly improve gold’s intermediate-term prospects.

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Clif Droke is a recognized authority on moving averages and internal momentum. He is the editor of the Momentum Strategies Report newsletter, published since 1997.  He has also authored numerous books covering the fields of economics and financial market analysis.  His latest book is Mastering Moving Averages. For more information visit www.clifdroke.com