A Gold Slip and Dollar Rally Amid Broad Risk Aversion is a Troubling Sign

A Gold Slip and Dollar Rally Amid Broad Risk Aversion is a Troubling Sign

Talking Points:

• Risk aversion picked up significantly this past week with the Nasdaq 100 entering a ‘bear market’ and S&P 500 close to its own milestone
• While an intense US index decline is a strong sign of risk aversion, breadth is another important factor – and fear has spread along that line
• Perhaps most remarkable of late in sentiment is the preference towards sheer liquidity which has bolstered the Dollar and lead to a gold retreat

Are the markets under pressure? That may seem an easy qualification to make if you are looking at a particular, favorite benchmark for sentiment and gauge any retreat according to a certain percentage slip from highs. That said, in a broad financial system as the one that we have, there are differing opinions and a certain degree of bullish skepticism that has kept the markets reverting to an inflationary climb so associated to capital markets like equities over the past few years. Even for the more optimistic amongst us, the markets seem to be listing towards serious concern.

The Nasdaq 100 – once a favorite, tech-centric speculative benchmark – slipped into a technical ‘bear market’ (correction of 20 percent or greater from highs) while the broader S&P 500 was closing in on its own tipping point after its worst week’s loss since the height of the pandemic. These are troubling performance figures, but it’s always good to look towards more systemic measures to gauge the sentiment beneath the more reactive surface.

Chart of S&P 500 with 2-Day Rate of Change and Level for Technical ‘Bear Market’ (Daily)

Source: John Kicklighter, TradingView

 

Risk Aversion is Starting to Spill Over from Just the Most Recognizable Names

A further step into measuring sentiment is to look for an alignment towards ‘de-risking’ across other regions and asset classes. There was no missing the weight being exerted on confidence across various speculative tributaries. Non-US equity indices, emerging markets, high yield fixed income, carry trade and other assets on the higher risk / higher yielding side of the spectrum were all registering substantial losses this past week.

When setting a baseline to the October 2022 low in the S&P 500, the comparative retreat from the recently set peak and high correlation is difficult to miss. Across so many different markets with significantly different fundamental backdrops and endogenous drivers, such alignment to both direction and intensity of repricing is more often a sign of a deeper current that often ties back to the systemic motivation of ‘risk appetite’.

Chart of Relative Performance of ‘Risk’ Benchmarks Baseline to October 2022 (Daily)

Source: John Kicklighter, TradingView

 

Sentiment is on a Spectrum – Where Are We On the Spectrum?

While it is easier to assess the difference between a general ‘risk appetite’ drive compared to ‘risk aversion’, the more measured comparison of modest to intense sentiment on one end of the spectrum can indicate a shift into a systemic and even self-sustained cycle. In light of that relative measure, it can be useful to compare the performance of a preferred speculative benchmark relative to a broader measure – like the tech-heavy Nasdaq 100’s advance relative to the blue-chip Dow - to gauge a fortified trend when markets are climbing. When that relationship starts to waver, it can suggest an erosion of conviction from unwavering risk appetite to a potential inversion, We can also make observations of relative safe havens to gauge the other end of the spectrum.

Scale of Sentiment and Asset Benchmarks that Align

Source: John Kicklighter

 

Gold is a Higher Degree Safe Have…But There is More Intense

On the ‘safe haven’ end of the sentiment scale, there are a number of recognizable assets that global investors tend to favor, such as: gold, US Treasuries, the Japanese Yen and US Dollar. The Japanese Yen represents one of the largest economies in the world (stable and a high sovereign credit rating), but more often, its appeal has been bolstered by the unwind of carry trade – pursuit of higher yields in other countries – the past few decades. A more recognizable haven of late has been gold. The precious metal has taken on a greater appeal amid the pressure of lower yields in financial assets with rate cuts (gold has no yield) and with the questions around currency stability amid capital distortions born of trade wars.

Chart of DXY Dollar Index and the VIX Volatility Index (Daily)

Source: John Kicklighter, TradingView

 

That mix had pushed the commodity to record highs through the past weeks. But, through the end of this past week, the metal notably took a hit while equities were pummeled. Gold didn’t suddenly lose its haven property, rather the need of absolute liquidity grew amid the growing fear. While gold is reliable and a cash equivalent, it doesn’t come close to the liquidity of the US Dollar – and the Treasuries that back it. If this dynamic persists, it may indicate a far greater intensity of risk aversion than a mere S&P 500 would suggest.

Chart of Gold and the VIX Volatility Index (Daily)

Source: John Kicklighter, TradingView

 

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-- Written by John Kicklighter, Global Head of Content