Shift in market psychology

December 15th, 2009

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The 4th December 2009 should be noted in your diary as the day where the market psychology has changed.

Prior to that day, any economic numbers that was better than expected will be interpreted by the market as being ‘good’ for commodity prices. The idea is that ‘good’ numbers imply economic recovery, which implies increased demand for commodities, which in turn implies rising commodity prices. As a side effect, the US dollar trends lower. The converse is true for economic numbers that was worse than expected.

After that day, there is a major shift in the market psychology. As we wrote in What happened to gold prices?, when the market believes that the economy is going to recover, it will anticipate and speculate on interest rate hikes by the Fed, which is bad for stocks and commodities and good for the US dollar. The logic, as we wrote in November 10 at Booming real economy, falling stock market?, goes like this:

A truly recovering real economy will result in liquidity draining out of the system. Since the current rally is fuelled by massive loosening of liquidity, draining liquidity will imply that the stock prices will fall and the US dollar strengthens. As the US dollar strengthens, then the short squeeze in the US dollar will happen (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which implies that the Aussie dollar and stock prices will tank.

Right now, the market is believing in the economic recovery story (which we are sceptical). This belief is not that strong yet because there is yet to be a large scale move in unwinding the US dollar carry trade.

Some of you (who are trading in paper gold) may be concerned about what’s happening to the gold price lately. But remember, the main story is the reversal of the US dollar carry trade (which will result in a rising US dollar). Gold (or whatever commodity you are trading) is not the lead actor in this story. If you notice, not all commodity prices are moving down in unison, unlike the great de-leveraging of 2008-2009. Falling commodity, gold, silver and stock prices are just the symptoms of the reversal of the carry trade. To the extent that the rise of the Aussie dollar is the result of the carry trade, this will imply a weakening Aussie dollar (see Return (and potential crash) of the great Aussie carry trade).

If you are investing in physical gold bullion, there is nothing to worry about (see our book, How to buy and invest in physical gold and silver bullion).