While their thesis has long-term merit, it may not be suited for short and medium-term trading.
With the gold bugs repeating their mistakes from 2021 and 2022, they remain steadfast that debt levels are too high, the U.S. economy cannot withstand higher interest rates, and when the Fed restarts QE, gold, silver and mining stocks will soar.
In other words, they follow the mantra, “the Fed is trapped,” which means no matter what officials do, they will fail. If they raise interest rates, debt becomes unaffordable, and the U.S. economy crashes. If they don’t, inflation runs rampant, and a crisis erupts.
Yet, 2021 and 2022 proved these theories were much more semblance than substance. And while some parts could prove accurate over the long term – because history shows 85% to 90% of the time inflation rises substantially, recessions follow and the Fed cuts interest rates – you need immense patience to wait for this outcome.
For example, please see what famous gold bug Peter Schiff wrote on Feb. 12, 2021:
Moreover, he wrote on Jan. 12, 2022:
Now, the unfortunate reality is that the U.S. dollar did not crash, the Fed did not reverse course and cut the U.S. federal funds rate (FFR) to zero, and gold’s performance has been mixed throughout that period. However, please remember that we’re concerned with the GDXJ ETF’s performance. Therefore, while gold has demonstrated relative strength, using Schiff’s thesis to trade the junior miners’ index has been a losing proposition.
Please see below:
To explain, the candlesticks above track the GDXJ ETF’s price. And if you analyze the vertical gray lines, you can see that the junior miners’ index ended the Feb. 12, 2021, session at $50.25 and the Jan. 12, 2022, session at $41.61. As a result, after closing at $36.05 on May 25, you would be down by 28% and 13%, respectively, if you held like a gold bug.
So, the main point is that a collapsing U.S. economy and an insolvent U.S. Treasury may combine for an interesting story, but it does not reflect fundamental reality. Conversely, the U.S. unemployment rate is at a 50+-year low, and the Fed has no reason to pivot when inflation is unstably high and the labor market remains resilient. If the unemployment rate rose to 5% or 6%, then an argument could be made. Yet, right now, it’s an easy decision for the Fed to prioritize fighting inflation.
On top of that, we warned on numerous occasions that the Fed has always pushed the FFR above the peak year-over-year (YoY) core Consumer Price Index (CPI). And with the latter peaking near 7% in this cycle, history is not on the pivot bulls’ side.
You Can’t Run From Reality
While the recession crowd opined that the recent bank runs would crash the U.S. economy, the economic impact proved minimal. Then, when tightening credit standards became the latest doom narrative, it breathed new life into the pivot bulls and helped uplift the PMs. But, we warned on Apr. 6 that the thesis was built on a faulty foundation. We wrote:
To explain, the red line above tracks the USD Index, while the green line above tracks the U.S. 10-Year Treasury yield. More importantly, the black line above tracks the inverted (down means up) December 2023 Eurodollar futures contract.
For context, Eurodollar is a proxy for the expected FFR. And since the yield moves inversely to the price, when Eurodollar rises, it means the crowd is pricing in a lower FFR.
Now, if you analyze the relationship, you can see that perceptions of a more hawkish Fed (higher black line) helped uplift the USD Index and the U.S. 10-Year Treasury yield. Conversely, the vertical gray line on the right side shows how the recent banking crisis has the crowd pricing in rate cuts by the end of December (lower black line), which has weighed on the USD Index and the U.S. 10-Year Treasury yield.
However, rate cuts are wishful thinking without a full-blown banking crisis, and a reversal of these expectations should rock the PMs in the months ahead.
To that point, with hawkish expectations rising dramatically recently, it’s no surprise the PMs have come under pressure.
Please see below:
To explain, the black, red and green lines above show how December rate-hike expectations, the USD Index and the U.S. 10-Year Treasury yield have erased roughly two-thirds of their bank-run moves, and their hawkish resets are profoundly bearish for gold, silver and mining stocks. For context, Eurodollar has been discontinued, and SOFR is the prominent FFR proxy.
Therefore, the fundamental thesis continues to play out as expected, and the crowd still underestimates the challenges of reining in inflation.
Speaking of which, S&P Global released its U.S. Composite PMI on May 23. The headline index increased from 53.4 in April to 54.5 in May, hitting a 13-month high. The report stated:
“Companies in the U.S. registered a solid upturn in business activity during May, according to the latest ‘flash’ PMI data from S&P Global. Overall growth in output was the fastest for just over a year. The expansion was led by service providers, however, as manufacturers recorded only a slight rise in production.”
In addition, the report added:
“Employment growth remained solid in May. Total private sector workforce numbers increased at the fastest pace since July 2022 as companies stated that a greater ability to hire and increased availability of candidates supported job creation.”
Thus, while we warned repeatedly that interest rates were too low to create the demand destruction necessary to tame inflation, S&P Global’s data continues to support that argument.
Overall, the gold bugs have a solid long-term argument that may play out in the years ahead. In contrast, we’re more concerned about the months ahead and have been consistent in our belief that resilient demand has only suffered a mild contraction. And until it becomes material, solid growth, employment and inflation should keep the pressure on the Fed.
Do you think “the Fed is trapped?”
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Alex Demolitor
Precious Metals Strategist