Dow Down 600 points! What's the reason?

S&P credit rating agency downgraded the long-term US debt by a notch just after the market closed last friday. As expected, the markets started tumbling even before the regular session started, as indicated by the Dow futures, which was down 260 points, pre-market. As the PM session took hold, Dow had a precipitous fall from down 300 to down 600 points. It was reminiscent of May 6, 2010, "flash crash."

But, oddly, the US dollar and the US treasuries were doing well! In fact, while traders sought the safe haven currencies like Swiss Franc (CHF) and Japanese Yen (JPY) across the board, USD did well against, AUD, CAD and EURO. So were the Treauries; the 10-yr yield slipped further down by 21 basis points to 2.339%. This is completely in contradiction to what should have happened after a downgrade of the Government debt. A downgrade entails higher interest rates, as investors demand higher returns commensurate with higher risk of owning a debt instrument whose potential for default is higher than before.

The reason for continued buying of US treasuries offers a great lesson for traders. While S&P downgrade spooked the markets, the fleeing investors/money mangers had to find a safe parking for billions of dollars. And, despite all the debt-related issues, US debt is still perceived to be the safest instrument out there. Until that perception is shattered, the money will still run to Uncle Sam.

Gold jumped by $65/oz today to $1700/oz. another safe haven play. EUR/CHF hit a low of 1.0615. Japanese Yen continues to appreciate against the USD despite a 200% debt-to-GDP ratio. This is all confusing, as many things look highly contradictory. But, what one must understand, at least in the short-term, is that, a trader would do well to run to gold, US treasuries, CHF, Yen, whenever there is a clear "risk-aversion" in the markets. Either you stay out of the markets or hedge your positions with the above instruments to avoid complete decimation of your account. And, "elevator down" events in the markets can turn out to be highly irrational, gripped by intense fear, a stampede of sorts, that can kill the faint hearted. Today, just like Thursday (8/4), was one of those days.

I think, more than the US downgrade, it was the Euro-zone debt issues, and the global economic slowdown--a potential "double dip"--primarily driving the markets today. In the absence of Fed's largesse through QE, and the inability of ECB to provide a "backstop" (they lack funds to stem the debt-deterioration in major economies like Italy and Spain), markets are bound to suffer further.

So, my conclusion is, QE 3 is very much on the horizon. The great market bear, Marc Faber, made a very sarcastic (I think it was sarcastic)comment last week: "Next week we will see whether Ben Bernanke is a true money printer or just an amateur." I have to concur with Marc. I think, if the market continues its slide, then QE 3 is very much the next monetary policy move from the US Federal Reserve. That means, gold will be heading toward $2,000/oz+. Equities will make a turnaround; treasuries will head down; so will the US dollar. So, brace for further loss of our buying power. Find a way to protect your dollar-based assets. It's a grave situation and sooner you plan to protect your assets, better you will be.

Good luck!