Notice the change of narratives in the financial markets?

July 6th, 2010

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At around January-February this year, when the global financial market first suffered a correction, the narrative was about the sovereign debt of Greece. That had the implication on the Euro. Back then, the US dollar rose and gold fell. The fact that gold fell was not something that can be rationally explained. That?s because if there?s a lack of confidence in a major fiat currency (the Euro in this case), then the alternative should be gold. But as we wrote in How To Foolproof Yourself Against Salesmen & Media Bias, there?s a difference between what should happen and what will happen. This is example of a divergence between the two.

In May this year, the narrative was again on Greece, the other PIIGS countries and by implication, the Euro. Gold and US dollar rose. This time round, gold?s move was rational.

Fast forward to today.

There?re a lot of indication that the narrative is back in the bears? favour (see Mr Market is in the bear camp). But this time round, there?s a difference between May?s bearish narrative and today?s bearish narrative- European sovereign debt (and by extension, the Euro) story is no longer part of the narrative. The more prominent story is the growing expectation of a double-dip recession. As we wrote in Keep up spending- Who?s right? Europe or America?,

The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

This narrative carries the implication of a return to deflation. The signs of deflation include rising US dollar and falling asset prices. Our guess is that in the context of this new narrative, gold in US dollar terms may be under pressure. A rising USD implies a falling AUD, which will mitigate some of the falls in gold price in AUD terms.

In the near term, stocks may be oversold and may rebound slightly. But according to the narrative of the bigger picture, the bears are still in charge.

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