Thursday, September 3, 2009

Gold and Financial Stocks: Markets as a Form of Expression

In recent days, the financial markets seem to have gone gaga. Gold is approaching $1,000 an ounce again. Bank and other financial stocks have rallied. The two trends are analytically inconsistent. Gold is favored when the economy is falling apart, inflation is surging or the political situation is deteriorating. In other words, it's an investment of last resort. Bank and other financial stocks make the most sense when economic trends look rosy. Since banks and other financial institutions lend to or invest in large segments of the economy, it is logical that they would rise when the picture looks good.

When both gold and financial stocks rise, cognitive dissonance sets in. But only if you assume markets are rational and interrelate with each other. While there may be a vague and general relationship between gold and financial stocks, for the most part, they are separate venues where different opinions are expressed through trading activity.

Markets require differences of opinion to function. Someone has to prefer cash to a stock, bond, gold or what have you, in order to sell. Someone else must prefer to own the stock, bond, gold, etc. instead of cash, in order to buy. These differences of opinion are the foundation for the supply and demand that interact in markets.

But different markets don't necessarily reflect the thinking of the same people. People who think inflation is around the corner and the economy is headed for a double-dip recession are snapping up gold. But they're very likely not selling or shorting financial stocks. People who see green shoots at every turn are speculating in financial stocks. But they're probably not selling gold or shorting gold stocks. Just as there is no unified field theory in physics, there is no unified financial market. Instead, gloomier investors express their opinions in one market. Optimistic (or opportunistic) investors express their views in a different market.

If you're trying to figure out what's going on, don't look for overarching explanations of all market activity. The last three times gold approached the $1,000 an ounce range (March and May of 2008 and February 2009), financial stocks were wobbly. Now, almost irrationally, they are not. What really seems to be going on is that in the low volume trading of the pre-Labor Day vacation period, different investor opinions are being expressed in different markets. These views can't easily be reconciled. Perhaps the most they indicate is the likelihood of greater volatility in the near term future.

Disagreements are a natural part of market activity. Avoid reading a lot of significance in recent gold and financial stock price movements. Gold reached the $1,000 range three times in the last 18 months, yet mobs don't rage in the streets and the Constitution remains the law of the land. The revival of financial stocks doesn't necessarily mean that all will be well. The financial markets are heavily populated with soothsayers and diviners that attribute talismanic significance to price movements of particular investments. There is no all-knowing indicator in the markets. There's simply the usual cacophonous potpourri of humanity.

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