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Could Gold Catch a Bid if Equities Stay Weak in 2018?

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Equity market sell-off

What the markets have long been fearing has finally come true, at least in part. The S&P 500 (SPY) (SPX) hit a record high on January 26, 2018. Since then, the index has fallen ~8% as of February 6, 2018.

The sell-off began after the US employment report was published on February 2, 2018. The sell-off was quite broad-based, with almost all sectors shedding gains. Banks, healthcare, and energy companies were slightly on the losing end.

In Equities May Have Limited Upside: Could There Be Room for Gold? we talked about how the risks in the equity market are becoming more pronounced and the upside more limited.

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Factors stoking the sell-off

Inflation worries are getting the lion’s share of the blame for the carnage in the equity markets. As inflation picks up the pace, the Fed could be inclined to raise rates more aggressively. Higher interest rates could stifle economic growth as it becomes more expensive for businesses and individuals to borrow money, restricting consumption.

Another factor spurring the sell-off could be profit taking by investors after the intense market rally, which was characterized by very low volatility. Moreover, the money from the sell-off isn’t making its way to US treasuries or other safe-haven assets, including gold, which might mean that initially investors are following a watch-and-wait approach and aren’t really anticipating a steep correction.

Underlying fundamentals still strong

Not much has changed as far as the fundamentals of the equity markets are concerned. Companies are delivering double-digit growth, and the US tax reform is acting as a nice catalyst. Going forward, however, growth could be modest and slower than what investors have been used to in the last 14 months.

Meanwhile, rising volatility could mean more outflows from the markets in the short term. Limited upside from equities, even in the medium term, could be a positive catalyst for gold.

Investors usually flock to gold when other investment alternatives aren’t doing well. A positive sentiment for gold could affect miners such as Royal Gold (RGLD), Barrick Gold (ABX), Kinross Gold (KGC), and Coeur Mining (CDE), which are leveraged plays on gold (JNUG).

Although royalty companies such as RGLD did well in 2017, other miner categories lagged. ABX and CDE returned -9.4% and -17.5%, respectively. With its return of 39.9%, KGC was an outlier in 2017.

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