Higher interest rates and evaporating liquidity should have the gold price seeing red during the winter months.
With risk assets selling off on Nov. 28, the gold price was caught in the crossfire; and while unrest in China has investors increasingly anxious, a common theme continues to rattle the financial markets. To explain, I wrote on Apr. 6.
Please remember that the Fed needs to slow the U.S. economy to calm inflation, and rising asset prices are mutually exclusive to this goal. Therefore, officials should keep hammering the financial markets until investors finally get the message.
Moreover, with the Fed in inflation-fighting mode and reformed doves warning that the U.S. economy “could teeter” as the drama unfolds, the reality is that there is no easy solution to the Fed’s problem. To calm inflation, it has to kill demand. As that occurs, investors should suffer a severe crisis of confidence.
To that point, St. Louis Fed President James Bullard said on Nov. 28:
“We've got a ways to go to get restrictive (…). I do think that the fact that the labor market is so strong gives us license to pursue our disinflationary strategy now and try to get the inflation under control right now so we don’t replay the 1970s where the FOMC at that time took 15 years to get inflation under control.”
As a result, while the crowd foolishly assumed that a dovish pivot was on the horizon, the hawkish realities of resilient growth, employment and consumer spending are highly bullish for the U.S. federal funds rate (FFR), real yields and the USD Index.
Please see below:
Source: MarketWatch
Likewise, New York Fed President John Williams said on Nov. 28:
“Inflation is far too high, and persistently high inflation undermines the ability of our economy to perform at its full potential. There is still more work to do.”
He added:
“My baseline view is that we’re going to need to raise rates further from where we are today. I do think we’re going to need to keep restrictive policy in place for some time. I would expect that to continue through, at least through, next year.”
Furthermore, while Williams said that a recession is not his base case, he warned that the U.S. unemployment rate could rise materially as the Fed’s inflation fight continues.
Please see below:
Source: Reuters
Moreover, while I’ve warned repeatedly that the Fed needs a higher unemployment rate to cool wage inflation, and therefore, output inflation, every inflation fight since 1954 has ended with a recession, and the current employment/inflation backdrop highlights why this time should be no different.
To explain, I wrote on Aug. 16:
With the consensus underestimating the destructive nature of inflation and overestimating the Fed's ability, the bulls should suffer a crisis of confidence over the medium term.
Please see below:
To explain, the red line above tracks the year-over-year (YoY) percentage change in the headline CPI, while the green line above tracks the monthly change in U.S. nonfarm payrolls. For context, the consensus cites near-record job openings and robust payrolls growth as evidence for why only a mild recession can occur (if one occurs at all).
However, the chart above highlights how unanchored inflation torpedoed that narrative in the 1970s. If you analyze the shaded gray areas (recessions), notice how the green line remained positive during the early stages of the recessions in 1970, 1974, and 1980? In a nutshell: monthly payrolls growth stayed positive during the outset of all three recessions.
If you focus your attention on the sharp drops in the green line near the end of the 1970, 1974, and 1980 recessions (negative monthly payrolls prints), you can see that reality re-emerged and the U.S. labor market suffered mightily. Moreover, negative payrolls growth was also present during the 1982 recession, but inflation was declining at that time.
So, while Fed officials’ FFR expectations have increased, and their projections for growth and unemployment have become more ominous, the crowd still doesn’t grasp the economic challenges that lie ahead.
Finally, while the gold price has risen materially in recent weeks, enthusiasm has not followed suit.
Please see below:
Source: World Gold Council
To explain, the gold line above tracks the gold price, while the colored bars above track the weekly North American, European, Asian and other fund flows into gold-backed ETFs and similar products. If you analyze the right side of the chart, you can see that outflows have dominated since late June and continued even as the gold price rallied in early November.
In addition, while $200 million in inflows were recorded last week, they were still less than the $400 million in outflows that occurred the week before. As such, investors have mainly used the recent rally to exit their gold positions, not add to them.
Overall, more downside should confront the gold price in the months ahead, as the Fed’s inflation fight ramps up; and with growth, employment and consumer spending still uplifted, I’ve warned on numerous occasions that the fundamental backdrop does not support a dovish pivot. Thus, while the stock market bulls have done a great job of buying hope and selling reality, the latter should bring forth plenty of disappointment over the medium term.
Alex Demolitor
Precious Metals Strategist