With momentum waning, the next major move could be lower.
While a short squeeze dominated the stock market on Jan. 23, gold, silver and mining stocks underperformed. Moreover, with their momentum sputtering at a time when hawkish winds blow stronger, swift declines should materialize in the months ahead. To explain, we wrote on Jan. 23:
The Cleveland Fed expects the headline and core Consumer Price Indexes (CPIs) to increase by 0.53% and 0.46% month-over-month (MoM) in January, which annualize to 6.5% and 5.7% year-over-year (YoY), respectively.
Now, analyzing MoM inflation will be useful going forward, as monthly changes allow for annual estimates of where YoY inflation will go if the current trends persist. Therefore, with these MoM figures well beyond what’s needed for the Fed to reach its 2% mandate, the implications are profoundly hawkish.
To put it in context, 2% annual inflation requires MoM prints of less than 0.17%. So, with the current data tracking well above that, a pivot contrasts fundamental logic.
Likewise, with inflation poised to remain more persistent than the consensus expects, the U.S. federal funds rate (FFR) should have plenty of room to run.
Please see below:
To explain, the colored lines above estimate the different YoY values for the core CPI near the fall of 2023 assuming various MoM prints. If you analyze the gold and dark blue lines above, you can see that continuous MoM prints of 0.40% and 0.30% will result in YoY core CPIs of 4.8% and 4.1%, respectively.
As a result, with the Cleveland Fed projecting 0.46% MoM in January, the bulls’ optimism continues to loosen financial conditions and spur more inflation; and with a continuation poised to keep the core CPI 2x to 2.5x the Fed’s 2% target, the data supports higher interest rates over the medium term.
In addition, we warned that China’s reopening would help stimulate commodity demand, and the backdrop is bullish for inflation. In the process, the FFR, real yields and the USD Index should benefit from the hawkish ramifications. Jeff Currie, Global Head of Commodities Research at Goldman Sachs, said on Jan. 11:
“What is the best [China] reopening play? It is oil. What is idled? Planes, trains and automobiles. You turn them all back on, that’s going to be a big pop in oil demand.”
Please see below:
To explain, the red rectangle above shows that Goldman Sachs expects the WTI and Brent oil prices to range between $85 and $99, and $90 and $105, over the next three to 12 months. Thus, while the crowd has celebrated the decline in the headline CPI – even though the Sticky CPIs have hit new YoY highs for 17 straight months – Chinese oil demand could flip the script in the months ahead.
Remember, China is the world’s largest oil importer, and the country had been in a strict lockdown for months, which weighed on oil prices. But, with that headwind no longer present, the inflationary impact is material.
Also noteworthy, the blue rectangle above shows that Goldman Sachs expects gold and silver to range between $1,850 and $1.950, and $21 and $23 over the next three to six months. Therefore, even though Goldman Sachs is a commodities bull, the investment bank sees more downside than upside for gold, and material downside for silver versus the Jan. 23 closing prices.
So, while it may ‘feel’ like the PMs have substantial upside, the optimists are preaching caution over the next three months. As such, we share that caution, and expect even larger drawdowns as the liquidity drain continues.
Speaking of which, while the crowd underestimates the peak FFR, they’re also dismissing the other elephant in the room.
Please see below:
To explain, the red line above tracks the six-month change in assets held by the four major central banks. If you analyze the right side of the chart, you can see that quantitative tightening (QT) is in full swing, and the magnitude is like nothing we’ve seen in nearly 20 years.
Consequently, while the bulls continue to follow the post-GFC playbook, we’ve warned numerous times that those rules no longer apply. With inflation highly problematic, central banks can’t run to the rescue like they did in recent years. As it stands, QE is history, and the bulls should learn this lesson the hard way over the medium term.
Furthermore, with demand still highly resilient, and North American central banks in a similar bind, the global tightening cycle should continue. For example, Mastercard released its Canadian retail sales report on Jan. 19. An excerpt read:
“Canadian retail sales, excluding automotive, increased +8.2% YoY in December,” and “In-store sales were up +10.4% YoY,” while “E-commerce sales were down marginally -0.1%.”
Michelle Meyer, Chief Economist for North America at the Mastercard Economics Institute, said:
“Without the pandemic restrictions of past holiday seasons, Canadians returned to in-store spending and celebrated the holiday season with family, friends and colleagues as seen by solid YoY spend increases in sectors such as restaurants, fuel and apparel.”
As a result, consumer demand was resilient versus the December 2021 figures (the left column) and robust versus the December 2019 figures (the right column), and the strength is bullish for short-term interest rates.
Please see below:
Overall, the economic data continues to move in a hawkish direction at a time when the PMs’ bullish momentum has started to dissipate. Despite the stock market’s enthusiasm, the gold price was flat and the GDXJ ETF declined; and with the PMs overvalued and the USD Index undervalued, we expect a reversal of fortunes in the months ahead.
Where do oil prices go in the next three to 12 months? Should the crowd be nervous about the inflationary impact? Why are the PMs not mirroring the S&P 500’s enthusiasm?
Alex Demolitor
Precious Metals Strategist