Indeed, the sell-off started right after the US Labor Department reported strong job growth in January and revised December’s numbers up, while also reporting that average hourly earnings rose 2.9%. For years the economy has repeatedly failed to meet inflation targets; to suddenly not only meet but beat expectations was, I guess, more than the market could handle.

That’s fair enough as a starting point. It’s also fair enough to state that the parabolic gains of December and January were never going to just keep going, and moves like that rarely taper gently – they correct.
 

However, while interest rates and inflation are playing a role, there’s a bigger picture that I think deserves comment.

The biggest trade of recent years has been to short volatility. To short is to bet against. After spiking to 60 in the financial crisis, volatility as per VIX (the CBOE Volatility Index) has held one clear trend: down. And seven years of decline had taken volatility to record lows.

In itself, this short-vol obsession was interesting (scary?) enough. The fact that it happened at the same time that index trading exploded (there are now more ETFs than there are publicly-traded companies – let that sink in for a minute) created an investment universe incredibly biased to low risk and no volatility.

If you can believe it, estimates suggest some $2 billion flowed into ETFs and ETNs (exchange structured notes) designed to benefit from decreasing volatility in January alone.

That all worked really well…until Friday and Monday, when volatility returned.

“Six years of picking up pennies in front of a bulldozer wiped away in one session.”
—  blogger Quoth the Raven, on Twitter

You might think a flood of money of that magnitude would show up in liquidity and volatility…but the opposite happened: market volumes declined and volatility was non-existent. The lack of liquidity exaggerated gains, creating a parabolic run-up in January:

It’s also the beginning of the end of the bull market, but that process could still take a long time. In fact, it will likely take a while. Global economic growth is finally happening. That is adding a lot of confidence to market that was already full of swagger. Unless something crops up to destroy that confidence (like a mortgage-backed security maelstrom), this has the makings of a bull market that slows but continues, making another peak or three but correcting in between as investors get increasingly wary of risk and start turning to safer havens.

Adding into the big picture is the fact that Treasuries are looking more attractive. In fact, for the first time since 2008, US 2-Year Treasuries are yielding more (2.09%) than the average dividend yield from the S&P (1.8%).

If this big-picture shift is indeed underway, if this correction brings risk awareness back to the market, then the rest of this bull market will be marked by considerably more volatility. The later stages of a bull market always involve more volatility – the peaks and corrections of greed and fear do that, fueled by confidence in economic acceleration and concerns about rising interest rates and inflation.

Volatility is not bad in itself. In fact, for the metals investor today I would suggest that the return of volatility is good. We need investors to get a bit spooked. As long as fear stayed on the sidelines, investors were going to keep doing more of the same. The return of fear will disrupt the mantra that the rising tide is lifting all boats; value stocks and income stocks will start to stand out versus growth stocks and broad baskets.

And the search for value will bring investors to metals and miners. There is just no other way. I’ve laid the arguments out in the last few issues so I won’t rehash them here, but the mining sector offers rare value in an overvalued market, reliably outperforms in the late stages of an economic expansion, and is supported by a weaker dollar and inflation concerns. Add to that the safe haven argument for gold and the entire metals complex is set up to do well.