Gold Breaks $1,000

Friday was a roller coaster day for the stock market. The Dow-Jones, down by over 200 points in the early afternoon, finished "only" down 100 points, as the Obama administration assured a nervous market that nationalization of banks was not imminent (apparently, many thought this weekend could have ended with a surprise not unlike we saw at the end of last year -- this time nationalization of both Citigroup and Bank of America). You can read about this.

While the stock market was gyrating, gold rose to over $1,000/ounce (click here for story). While that is not far from the record in nominal terms, it was very far from the all-time record in real terms (around $2,200 in 2008 dollars). The move to gold was a flight to safety, not unlike what we often see for bonds (review Supply and Demand notes). Globally, markets are unsure about how long and severe this recession will be. So, rotate from stocks to bonds (interest rates fell Friday) and gold. Part of what underlies this uncertainty can be seen all too vividly with the following graph:

Gains that accumulated over five years have been wiped out over the last year and a half! We have now broken below support from 2002. Look closely at the most recent two price bars and the information they contain.

Where do we go from here? The only good news in the chart is that the RSI is giving an extremely oversold reading (of around 10). So, based on the way markets usually work, we are due for an oversold bounce. But other things are not equal. So, when might the bounce occur?

This is where you need to add economics to model the Dow-Jones average. Recall, the two primary factors moving it are interest rates and profit expectations. Interest rates for now are not a concern, so focus primarily on profit expectations. Predicting them necessarily requires a forecast of credit availability and financial system workings (read this intriguing article). Because this is so uncertain at present, opinions change every day. As market participants continue to change their minds often, they move in and out of different assets and stock sectors, causing volatile stock prices (referred to as the repricing of risk).

Expect this to continue until markets see a predictable (not necessarily effective) direction for financial markets, housing prices, and overall economic activity. ALL THREE ARE ENDOGENOUS AND SIMULTANEOUSLY DETERMINED.