Investors Need to Be Wary of Crowds
The trend is your friend in financial markets, but investors also need to be wary when a strong consensus emerges on the likely price direction in any one market. To my mind, bond yields and share prices now seem most vulnerable to a shift in currently consensus bullish sentiment, though this may well entrench the other consensus trade of selling the Australian dollar and gold.
I’ve long been bearish on both gold and the Australian dollar. Indeed, my long held view that gold and the Australian dollar will keep falling and the US dollar will rise has been driven by the conviction that America’s economic recovery will retain enough momentum that US quantitative easing would end on schedule this year, before US interest rates are eventually lifted in early/mid 2015. Due to the underlying strength of the US economy, moreover, I’ve not been fearful that the early withdrawal of Fed stimulus would kill the equity bull market.
So far this scenario is still playing out, with further solid US labour market reports this week suggesting the economy is picking up speed nicely.
In fact, such is the strength in the US economy, one looming risk is that markets will soon be once again spooked by the prospect or earlier rather than later US interest rate increase – which remains my core view.
To my mind, expectations that the Fed won’t touch interest rates until late next year seem overly complacent, especially if the unemployment rate keeps falling and wage growth starts to firm. In turn, that could soon produce another knee jerk correction in share prices and a further lift in the US dollar.
But if this is the next shock to hit markets, it’s only likely to entrench the downtrend in gold and the Australian dollar. Indeed, I get the sense that that are a lot of stubborn gold bulls still in denial, and think that prices will soon stabilise due to cut backs in gold production – or that perhaps further quantitative easing policies by the Bank of Japan or the European Central Bank could somehow give the precious metal a second wind. Similar thinking - namely cut backs in production will support prices - is pervading the outlook for iron ore prices, and some still feel Australia’s still relatively high interest rate will slow the speed of the A$’s decline.
I beg to differ. The $A remains very vulnerable to a quite a marked slide in coming months, and the sell-off in gold prices risks becoming a rout.
If there is a bounce in any of these markets any time soon, I would strongly urge investors to see this as a fresh shorting opportunity – or at least once last chance to get out of stale long positions at reasonable prices.
Gold production may well be cut, but its shifts in demand for the existing stock of gold that really drives prices. And there’s still a lot of demand stored up in exchange traded funds around the glove that can be liquidated as the price outlook sours. As for the Australian dollar, our relatively soft economy, falling commodity prices, and America’s economic strength remain major negative forces.
The best news for our economy is that the A$ is likely to fall against the backdrop of a strengthening US economy – which bodes well for export markets.
While the A$ drop is too late to help much of the remaining manufacturing sector we’ve lost in recent years, it should breathe new life into less capital intensive trade exposed service sectors, like tourism and education. As we’ve seen with the run up in building material stocks thanks to the housing upturn driven by low interest rates, the weaker $A is now likely to see a strong turn in sentiment toward the tourism and leisure sector.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.