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Equity Market Correction: The Next Catalyst for Gold Prices?

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Equity market bull run

The US equity market has been on an upward trend since the US presidential election in November 2016. The S&P 500 Index (SPY)(SPX) rose nearly 30.0% between November 2016 and March 2018. The expectation of various reforms, deregulation under the new administration, and an improvement in various fundamental factors primarily supported the market movement. 

The equity market’s valuation is also high compared to its historical average. Moreover, the bull run by the equity markets in 2017 was accompanied by very low volatility.

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Equity market sell-off

After stronger-than-expected inflation data, the market sell-off in February 2018 stoked concerns of a more aggressive Fed. This scenario would have been negative for economic growth. 

The equity markets dropped again on March 23, 2018, on trade war fears as the Trump administration talked about imposing additional tariffs on Chinese imports. The markets calmed afterward on hopes that the US and China could resolve these issues before the start of a full-blown trade war.

Is more correction ahead?

The question now is whether the recent stock market correction is just that—or the beginning of a larger downtrend. Going by the current valuations versus historical valuations, the market seems to be a bit too stretched. 

Allianz’s CEO, Oliver Bate, shares this view and noted, “Equity markets have really been buoyant for a long time now and valuations are extremely high, higher than you can actually justify based on fundamentals. 

Bate continued, “Markets are starting to get jittery and we would expect a more severe correction over the medium to long term.”

Bank of America Merrill Lynch also warns of a potential correction. Multiple factors could lead to the downside for the markets from here, including a faster rate hike scenario from the Fed, trade issues, and higher inflation.

A haven asset

Investors usually flock to gold when other investment alternatives aren’t doing well and uncertainty is rising. 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 Royal Gold did well in 2017, other miner categories lagged. Barrick Gold and Coeur Mining returned -9.4% and -17.5%, respectively. With its return of 39.9%, Kinross Gold was an outlier in 2017.

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