The first fiscal quarter of 2017 officially ended on Friday of last week as US equities posted another solid weekly and monthly gain. Despite the longer-term trend of decent gains, equities around the world were mostly mixed during trading on Friday.

For equities in Asia, Hong Kong’s Hang Seng Index was down 0.78%, while Japan’s benchmark Nikkei 225 was down 0.81% for the day. Trading was not much better in Europe either, as London’s FTSE 100 closed down 0.63% for the day.

Analysts are attributing the lackluster final day of Q1 trading to the incredibly persistent political and economic uncertainty that started late last year and has ceased to abate. This is especially the case for equities in Europe, as British Prime Minister Theresa May signed and invoked Article 50 and officially started Brexit.

From when the article was invoked on Wednesday of last week, there are now less than two years and counting before the UK physically withdraws from the EU. In spite of the 24-month time-frame before any changes are felt, the signing of Article 50 seemed to unnerve some investors.

In terms of commodities, crude oil is back above $50 per barrel and ended with a sizable weekly gain of over 5.50%. Gold and silver are slightly negative for the month, but both metals posted an impressive gain of over 8% and 13%, respectively, for the first quarter.

Coming off a failed health-care reform attempt last week and a subsequent market sell-off of equities and other risk assets, investors looked towards economic data this week to gauge the direction of the economy.

Because of this, overall investor worry (measured by the VIX index) declined last week after a multitude of outstanding economic data was released. In fact, equities rallied nicely on Tuesday after consumer confidence exploded to the highest level since 2001. Domestic equities continued their gradual upward drift throughout the week.

As the second quarter is now here, so is a new earnings season. Judging by the surprisingly upbeat economic data released in the past few weeks, it’s safe to say market participants will not be overly shocked to see companies releasing solid earnings. If earnings reports are strong, markets will, as a result, edge higher. Earnings reports are only released four times per year, and they are one of the major drivers of overall market direction.

But many investors are not so sure Q2 will be full of rainbows and sunshine. With political uneasiness that just refuses to go away, apprehensions about the market are commonplace. Moreover, margin debt, or the amount of money retail and institutional investors borrow against their brokerage accounts for additional buying power, hit an all-time high in February.

This means market participants are using a lot of leverage with the expectation that prices will rise. If, however, prices fall dramatically, things could turn sour very quick due to the unprecedented level of leverage.

All-time market highs, all-time margin debt, and shocking political upsets (Brexit and the US election) all occurred during Q1, defying almost everyone’s expectations. So what does Q2 hold for the markets? The simple answer is: it’s anyone’s guess.

It’s been said that the market can manage bad news; It’s the uncertainty that kills. For investors, uncertainty carries the name volatility. In recent months volatility, as seen by the CBOE “Fear Index,” has been flat. This calm presumably permits investors to embrace the market rally without trepidation, right? Maybe not.

There is an unseen phenomenon at work. “Days when the VIX or VStoxx goes up have normally in the past been days when the stock market falls, as higher expected volatility shows more risk is anticipated,” remarks Wall Street Journal Author James Mackintosh. However, “That link has partially broken down, with stock prices often rising when implied volatility rises.” This bravado among investors may be explained by blindness to volatility because “big swings by sectors within the S&P 500 have largely offset each other,” explains Mackintosh.

Volatility is rising even if the VIX isn’t. 

Such nascent volatility underscores the need for investors to remain proactive in their risk mitigation. Gold has shown effectiveness in achieving this end. Research from BlackRock dating back to 1994 illustrates that “In months when volatility rose, gold outperformed the S&P 500 price return by roughly 2% on average.” This relationship amplifies during periods of excessive volatility. That is when the VIX rises above already heightened levels gold becomes an even more effective hedge. The same data from BlackRock shows that when the VIX pushes north of 20 gold delivered performance 5% above the S&P 500. These are valuable lessons for investors who, perhaps unknowingly, rest their portfolio above a fault line in the U.S. and global economy.

Additional research has reinforced the connection between gold and periods of heightened investor anxiety. There is a clear correlation between the price of gold and the spread between the 3-month interbank rate and the 3-month T-Bill rate. The divergence of the interbank rate and the T-Bill rate is called the “TED Spread.” The measurement is an internationally accepted gauge of credit risk in the overall economy. An increasing ‘TED’ spread indicates greater risk in the market. Decades of measurements show that as credit risk grows gold rises thereby proving its hedge characteristics. Periods of pronounced uncertainty elucidate this correlation particularly “in the 1970s when massive spikes in the ‘Ted’ spread were associated with sharp rises in gold,” according to research from Oxford Economics. This same body of research determined that gold “has a zero or negative correlation with other assets, so its inclusion in the portfolio reduces the overall volatility.” The authors posit that even an allocation of 5% towards gold in a portfolio allows investors to benefit from the stability offered by an asset that responds differently to market conditions.

Investing is a long game. However, in the long-term volatility is inevitable. Investors are wise to embrace this truth rather than fight it. The smart way to withstand the rise and fall of the market is to buttress your portfolio with a diverse asset allocation that ventures beyond the traditional mix of stocks and bonds. Historically, gold fulfills this role by rising amid periods of anxiety and uncertainty. As topics like overvaluation in the equities market continue to escalate, it seems likely that gold will once again prove its mettle.

Is the equity market bull beginning to crack?

Last week, on March 21, the S&P 500 experienced its first 1%+ closing decline since October as the market tumbled 1.25% at the final bell and dragged 10 if its 11 sectors down with it.

There is a growing chorus on analysts on Wall Street who are warning about the potential for a stock market retrenchment ahead. “Our analysis suggests it is likely the S&P 500 rally will fade in the second half of this year as concerns over wage inflation in 2018 and possible Fed rate action may create equity headwinds,” said Scott Wren, senior global equity strategist at Wells Fargo Investment Institute.

What Lies Ahead For Stocks

First-quarter 2017 S&P 500 earnings season starts during the week of April 10, and the “Sell in May and Go Away Period” will begin April 30.

The May through October period are notoriously the bleakest months of the year for the U.S. stock market. Most of the market’s infamous stock market crashes have occurred during September and October.

After decades of historical research, the folks at The Stock Trader’s Almanac discovered that most market gains occur during the months November through April.

“Since 1950 the DJIA is up 7.4% on average during the Best Six Months November-April, while it is up only 0.4% during the worst six months May-October.” – Stock Trader’s Almanac.

What drives this phenomenon? It’s driven by the annual business cycle and the fact that Wall Street business activity dries up during the summer months from Memorial Day- Labor Day as well as the impact of quarterly portfolio adjustments of fund managers, according to the Stock Trader’s Almanac.

The “E” Needs To Catch Up With the “P”

The stock market is about to face a flurry of first quarter earnings news, as well, during a time of historically expensive stock prices. The S&P 500 is currently trading at a Price/Earnings ratio of 19.5 which is a 13% premium to its median average since 1988. That’s expensive and underscores how the recent stock market gains since Election Day have put the cart before the horse.

“The stock market rally over the last several months had been built on the notion that President Trump would come in, pass sweeping pro-business reforms and launch infrastructure spending programs quickly and efficiently and with little opposition, boosting corporate earnings this year,” says Colin Cieszynski, chief market strategist, at CMC Markets.

“These dreams, however, are starting to run into reality and because of this, stocks are starting to crumble. The tipping point appears to be the ongoing debate over health care reform. The inability of Republicans to agree among themselves has spooked traders concerned that tax reform may also be more difficult to achieve than previously thought with border taxes particularly contentious,” Cieszynski adds.

Gold Benefits From Save Haven Buying

The growing political risk in the United States has sparked a flight of capital and gold is benefitting as a safe haven. The outlook for gold, silver and other precious metals remains bullish. Gold and silver prices are climbing and we are likely seeing the lowest price points for buyers in 2017 right now.  

There is an old saying among traders: No market trades in a vacuum. Just like economies are interrelated in today’s global economy, various markets rise and fall and impact each other.

If you are investing in gold, there are two other markets you could consider keeping an eye on as well. These two markets can offer clues regarding the direction that gold (and other precious metals) are heading and the potential strength of that trend. Here they are:

1. Dollar Index

Many traders like to keep an eye on the U.S. dollar index as a proxy for whether the U.S. currency is strengthening or weakening.

The U.S. dollar index is a “basket” of six component currencies,

which includes the euro, the Japanese yen, the British pound, Canadian

dollar, Swedish krona and Swiss franc. The euro takes the biggest chunk

of the U.S. dollar index, accounting for 58%, which does give it some

outsize influence. The yen is the next biggest weight at 14%.

The U.S. conducts plenty of trade with both the Euro zone and Japan, which does make this a useful index. There are some currencies left out (Chinese yuan, Mexico peso and Korean won) and the U.S. does do a lot of business with these countries. But, from a trading signal standpoint, traders tend to rely on the U.S. Dollar index when it comes to gold.

Why this matters to gold? The short answer is that gold tends to have an inverse relationship to the U.S. dollar index. The simple reason is that gold is bought and sold on world markets in U.S. dollars. A rising U.S. dollar trend makes gold more expensive to foreign buyers and tends to weigh on demand.

2. Crude Oil

The price of a barrel of crude oil can be important indicator for the gold market as well. The trend in crude oil prices is one factor (but certainly not the whole picture), which impacts the trend of inflation or higher prices.

Energy prices are a major component for inflation with a “trickle-down” impact throughout our economy. If the price of a barrel of crude oil is trending higher, that makes gasoline at the pump more expensive for consumers. But, it goes much farther beyond that. Just think of jet fuel for cargo and delivery (FedEx and UPS), and passenger airplanes and diesel fuel for trucks. Rising crude means higher transportation costs for everything. The food that is trucked across country. The boxes of goods that are delivered to your local Target store via truck. The price of your plane ticket to visit your new grandchild.

Rising transportation costs affect just about every area of the economy and those costs are passed along to consumers in the form of higher prices. Gold is a traditional inflation hedge and rising inflation is a supportive factor to the gold market.

Typical Relationship

Crude Oil Up = Gold Up

Crude Oil Down = Can be a gold-negative or neutral

Not all market relationships are 100% correlated all of the time. Relationships do break down. But, these are two of the general outside markets that can influence the price of gold.

Market Snapshot Now:

• S. Dollar Index – from its 2017 peak to trough, the U.S. dollar index is down 4.42%
• Crude Oil – From its 2015 low at $26.05 per barrel, crude oil skyrocketed 112% to its 2017 high at $55.24 per barrel.

What did not come as a surprise to markets around the world, the Federal Open Market Committee hiked their benchmark lending rate last week by 25 basis points, or 0.25%, to the current rate of 1%. Fed fund futures traded on the CME showed about a 94% probability of a rate hike going into Wednesday’s announcement.

Despite the virtual certainty of a rate hike, there were dramatic moves in the financial markets across a wide range of instruments.

The S&P 500 immediately rallied after the announcement, and, along with the Nasdaq and Dow, finished the week with a noticeable gain of around 0.50%. “Stocks in general are much more attractive relative to other liquid asset classes,” said Diane Jaffee, portfolio manager at TCW, a Los Angeles-based asset manager with nearly $200 billion under supervision.

But stocks weren’t the only asset class that popped. On the fixed-income front, Treasury note and bond futures absolutely surged after the announcement. The yields on 10-year Treasury and 30-year bonds notes saw an instantaneous increase and finally broke a two-week-long losing streak.

For currencies, the US dollar index tumbled to the lowest level in over a month as a result of the Fed’s slightly hawkish outlook. The weak US dollar gave rise to higher gold and silver prices, as the most popular precious metals in the world are dominated in US dollars.

In terms of commodities, gold, silver, and palladium were all up well over 2% for the week to post the best week since February. Most of the losses for precious metals in the past couple of weeks have been recouped. Generally speaking, higher interest rates are bad for assets like equities and gold, because an increase in borrowing costs means it gets more expensive to borrow money to purchase these assets.

Nevertheless, the CEO of investment firm Amplify Investments said, “I am bullish on gold prices as I believe the U.S. dollar will continue to weaken.” From a global-macro perspective, a weakening US dollar is certainly not out of the cards, and this would ultimately benefit precious metal assets and other commodities, yet a weak dollar is not the only bullish argument for gold; global political uncertainty is definitely contributing to the rise.

Despite the gold/interest rate logic, investors seemed largely unfazed by the reality of an increased cost of borrowing. In fact, many interpreted it as an overall positive sign that the economy is finally normalizing and moving away from a zero interest-rate environment.

As noted in her speech, Fed Chair Janet Yellen expects the FOMC to raise rates at least two more times this year and at least three times in 2018. For reference, rates were only raised once in 2016.

Contrary to the current state of politics in the US and abroad, the state of US monetary policy seems to be pretty clear: the era of free loans is officially over, and policy is tightening to the direct benefit of stocks and dollar-dominated commodities, like gold.