Kitco Commentary

Kitco Commentary

Could Debt Ceiling 2013 Trigger A Stock Sell-off and Gold Market Rally?

Monday May 20, 2013 08:04

Editor’s Note: Seasoned Metals Analyst, Kira McCaffrey Brecht shares her extensive commodities knowledge on Kira has been writing about the financial markets for over a decade — posts during her career include Managing Editor at TraderPlanet, Chicago Bureau Chief at Futures World News, Market Analyst at Bridge News and Technical Analyst for MMS International and Managing Editor at SFO Magazine.

The U.S. Congress is no closer to a comprehensive deficit reduction agreement now than it was two years ago when the 2011 debt ceiling crisis hit, which resulted in a historic downgrade of U.S. credit by rating agency Standard & Poor’s.

Looking back at 2011, the political standoff and bickering triggered a swoon in the U.S. stock market and was a factor supporting gold prices to rally to all-time highs. Will the U.S. Congress usher in a repeat performance this summer?

The U.S. Treasury Department defines the debt limit here: The debt limit is the total amount of money that the U.S. government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. The debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past.

Additionally, according to the U.S. Treasury, since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit 49 times under Republican presidents and 29 times under Democratic presidents.

The debt ceiling limit, however, has become a politicized and polarizing issue surrounding the philosophical roles of government and the appropriate level of government spending as the U.S. national debt has topped $16 trillion.

While U.S. stocks continue their unrelenting rally to new all-time highs in most major indexes, stock analysts warn the market is vulnerable to a correction at any time. Stocks are rallying in large part due to the unrelenting support of the U.S. Federal Reserve and continued quantitative easing with $85 billion in new money pumped into the financial system each month. As the saying goes, Don’t Fight the Fed. Equity investors feel like the central bank has got their back.

Kitco Commentary

But, for now, the economic numbers in the real economy remain sluggish and challenged. Despite the Fed’s extraordinary efforts, the real economy has yet to show significant signs of strong growth and substantial improvement in the labor market. The U.S. stock market is vulnerable to a correction or even a new bear market. Another debt ceiling crisis in 2013 could be a trigger for that.

Let’s look at the numbers from the period surround the 2011 U.S. debt ceiling crisis. From the May 2011 high to the October 2011 low, the S&P 500 fell just over 21%. Meanwhile, from May 2011 to the September 2011 high, nearby gold futures gained over 29%.

Congress voted in January 2013 to extend the current debt limit until May 19. But, accounting logistics allow the government to run perhaps until September or October before it actually runs out of money to pay its bills. Watch for this to be an important topic in the weeks ahead.

While there is no guarantee that history repeats itself, it appears the central players have not changed their lines. Until some flexibility and compromise and real deficit reduction work begins in the U.S. Congress, the stock market is vulnerable to another shock, correction or bear, which in turn would most likely support the gold trade if another debt ceiling debacle unfolds.

By Kira Brecht, follow her on Twitter @KiraBrecht

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