After gaining during the second year of the pandemic, the stock market was turbulent in recent weeks.
The S&P 500 tumbled in January, nearing a correction, meaning a drop of 10%. And then it bounced back, but some analysts say the turmoil might continue well into 2022.
What is behind this market roller-coaster and how can it affect the gold price?
What happened in the stock market?
In January 2022, the U.S. stock market has suffered its worst first month of the year since the global financial crisis in 2009.
The S&P 500 index fell 5.3%, which was its biggest monthly decline since the start of the coronavirus pandemic in March 2020.
What dragged the stock market down? Analysts outline three key reasons:
- The Federal Reserve’s plans to raise interest rates
- Slowing corporate earnings
- Mounting geopolitical tensions
Let’s look at each one of them in detail.
Reason #1: Higher interest rates
The Fed has promised to hike interest rates this year to tame runaway inflation, which has recently hit its highest level in four decades.
But it seems that the idea of higher rates have spooked stock investors, and the reasons seem to be twofold:
- Higher rates could risk causing a slowdown of the U.S. economy.
- They could also make other investments like bonds become more attractive relative to stocks.
The thing is, when the Fed raises its benchmark interest rate, banks and lenders tend to increase borrowing costs, too. Credit cards, mortgages, and other debt become more expensive, reducing consumer spending and demand. Therefore, businesses have to pay more to stay open.
Generally speaking, this hurts the outlook for company profits and reduces investor enthusiasm for buying their stock.
Reason #2: Slowing corporate earnings
There are signs that a sharper economic slowdown could be underway. According to the latest survey of retail managers, activity in America’s service industries has fallen to an 18-month low. And the situation in Europe is not much better: retail sales in the Eurozone slumped 3% in December from the previous month.
The slowing economy is likely to squeeze company profits that have already been hit by the rising costs we mentioned above.
As an example, Goldman Sachs' Chief Executive Officer has recently warned of “wage inflation everywhere” just as the Wall Street bank reported a blowout year for profits, jangling the nerves of investors.”
Reason #3: Geopolitical tensions
Geopolitical risks are very difficult to price into stock markets, but several analysts said mounting tensions over the Russia-Ukraine crisis had hurt technology stocks and the broader market in the second half of January.
And if the crisis continues, and the West slaps stinging economic sanctions on Russia, global energy prices are likely to go up at a time when economies are already struggling with inflation.
“What I do know is if those tanks cross the border, oil will go above $100 a barrel. We’ll certainly feel it on the European gas market. We’ll feel it on the wheat market. We’ll feel it across a variety of markets,” RBC head of global commodities strategy Helima Croft said.
In short, if Russia were to move its troops across the Ukrainian border, it could cause a major risk-off* event, sending stocks lower and commodity prices even higher.
*In risk-off situations, investors become more risk-averse and sell their risky assets, therefore sending their prices lower.
What do experts say about the stock market?
In general, it’s a rule of thumb on Wall Street that January sets the tone for the whole year. By this measure, the forecast for stock markets in 2022 looks quite gloomy.
Morgan Stanley’s Michael Wilson told investors to “hunker down for a few more months,” stressing that “it’s too early to be bullish” and warning the S&P could plunge another 10%.
Once inflation slows down after the interest rate hike, Wilson said he was “most bearish” on consumer goods, and apparel and housing-related stocks that have benefited from higher prices.
But not everyone feels pessimistic about the stock market’s short-term performance. According to Frank Panayotou, a managing director at UBS Private Wealth Management, the drop in stock prices this year “seems overdone and represents a buying opportunity for long-term investors.”
At the same time, he warned that “investors need to be prepared for more volatility and overall more muted equity market returns than we have been accustomed to in recent years.”
And if this were to happen, volatility in equities and geopolitical tensions usually provide support for save-have assets, such as physical gold and precious metals.
How this turmoil in the stock market could affect gold?
Usually, gold tends to be resilient during stock market crashes because the two are negatively correlated. In other words, when one goes up, the other tends to go down.
Take a look at the chart below:
There are some reasonable conclusions we can draw based on this historical data. As we can see, in most cases, the price of gold increased during the biggest stock market crashes.
And how has the gold price reacted to the current stock market turmoil? Here’s what Nicky Shiels, Head of Metals Strategy at MKS PAMP GROUP, says:
“The traditional thinking would assert that escalating geopolitical risks together with equity market volatility is a bullish Gold combination to allow for a technical breakup/out.”
In other words, rising geopolitical tensions and stock market volatility are considered to be traditionally supportive for gold and are therefore generally expected to drive the price of the precious metal up.
Similarly, Goldman Sachs has increased its outlook for gold in 2022, predicting that its price could hit $2,500 an ounce if inflation remained elevated.
The bank said in a recent note: "For investors looking for a way to hedge their portfolios from risks of a growth-slowdown and falling valuations, we believe a long gold position would be more effective in the current macro environment.”
Yes, you read it right, that’s Goldman Sachs basically saying it could be smart to buy gold now.😉
What’s the bottom line
To quote the great baseball-playing philosopher Yogi Berra, "It's tough to make predictions, especially about the future."
This is especially true when it comes to financial markets.
Even if you had a crystal ball or the magical ability to read news headlines in advance, it would still be difficult to predict what is going to happen.
Investors are bracing for a year of rising interest rates as the Fed attempts to tame inflation. But if inflation continues to rise or if the Fed is forced to aggressively raise interest rates to keep it under control, it could be bad news for stock prices.
Furthermore, unexpected geopolitical events are always a risk for investors. Any escalation of conflict between Russia and Ukraine would most likely result in unprecedented U.S. sanctions on Russia, which would also strike a blow to global financial markets.
While no one knows for sure, all these factors could potentially trigger a stock market crash in the future. Have you already diversified your portfolio with a safe-haven asset?