Just yesterday, we considered the probability that gold would move to $1,900 this week to be less than 40%. Now, however, as silver has not recorded any better results and the strength of PM is relative to the USD index - these chances are close to 50/50. Even so, keep in mind that even if gold is rising, it does not mean that mining will largely follow it. On the contrary.
It seems quite likely that the miners' last peak is behind us, but it may be a while before the decline really begins. Is this the beginning of the end of a relatively wide topping pattern? If so, a very similar situation to the one we saw with the GDX ETF could repeat itself.
While I’ve been warning for months that inflation would come in much hotter than the Fed or market participants had expected, now, inflation is front-page news. However, amid the U.S. dollar’s recent surge, the commodities complex is sending an ominous warning to gold, silver, and mining stocks.
For example, copper prices are down by nearly 6% this week (as of the Nov. 17 close), while crude is down by more than 4% and natural gas is down by more than 11% over the last week and a half. And while I warned previously that the narrative of ‘hyperinflation’ is much more semblance than substance – due to the fact that perpetually higher prices eventually lead to demand destruction – the U.S. government’s war on inflation is intensifying.
To explain, I wrote on Nov. 11:
Surging inflation is now rattling The White House. Releasing a “Statement by President Biden on Today’s Economic News” on Nov. 10, an excerpt read:
Source: The White House
Moreover, Biden added:
“I am travelling to Baltimore today to highlight how my Infrastructure Bill will bring down these costs, reduce these bottlenecks, and make goods more available and less costly. And I want to reemphasize my commitment to the independence of the Federal Reserve to monitor inflation, and take steps necessary to combat it.”
And firing another missile on Nov. 17, Biden wrote a letter to the U.S. Federal Trade Commission (FTC) that outlined accusations of “illegal conduct” and anti-consumer behavior by oil & gas companies. An excerpt read:
“The Federal Trade Commission has authority to consider whether illegal conduct is costing families at the pump. I believe you should do so immediately.
“I do not accept hard-working Americans paying more for gas because of anti-competitive or otherwise potentially illegal conduct. I, therefore, ask that the Commission further examine what is happening with oil and gas markets, and that you bring all of the Commission's tools to bear if you uncover any wrongdoing.”
For context, the U.S. Energy Department said that crude accounts for half of the cost of retail gasoline – with taxes, refining, transportation, and distribution making up the rest of the spread.
More importantly, though, with investors, the Fed, and The White House now realizing that inflation won’t abate on its own, the latter has gone on the offensive. And with its monetary counterpart poised to follow suit in the coming months, the PMs are caught in the crossfire.
To explain, surging inflation is a tax on consumers. And with perpetual price increases reducing consumers’ purchasing power, unabated inflation threatens to derail the U.S. economic recovery. As evidence, real average hourly earnings – which subtracts the inflation rate from the percentage change in U.S. average hourly earnings – decreased by 0.5% month-over-month (MoM) and 1.2% year-over-year (YoY) in October (the red boxes below).
Please see below:
Source: U.S. Bureau of Labor Statistics (BLS)
In a nutshell: the data means that inflation is rising at a faster pace than average U.S. wages and consumers’ purchasing power has declined. For example, if average wages increase from $100 to $105, consumers are worse off if the average cost of goods increases from $100 to $106. Moreover, the longer this dynamic persists, the more it hurts the U.S. economic recovery.
Likewise, the University of Michigan released its Consumer Sentiment Index on Nov. 12. And with the index hitting a 10-year low, it’s no coincidence that The White House (and soon likely the Fed) has made inflation Public Enemy No. 1.
Please see below:
Source: the University of Michigan
Thus, the hyper-inflationists are missing the forest through the trees. In their argument, they assume that high U.S. debt levels make raising interest rates impossible. As a result, the U.S. government will allow inflation to run rampant and the U.S. dollar will crash in the process. However, while it’s an interesting story, it’s unrealistic. And why is that?
Well, for one, not raising interest rates will likely do more harm to the U.S. economy than tightening monetary policy. And the reasons are outlined above: if prices keep rising and consumer confidence keeps falling, eventually demand destruction unfolds. As a result, if policymakers don’t solve their inflationary conundrum, failure to do so will likely push the U.S. economy into recession.
Second, the political component shouldn’t be ignored. Biden’s approval ratings keep hitting new lows along with consumer confidence. Thus, is it in his best interest to maintain the status quo? Of course not. That’s why he’s been so forceful on inflation over the last few weeks. Essentially, if he (and/or the Fed) does nothing, he’ll likely lose the next presidential election and the Democrats will likely lose control of Congress. However, if he tames inflation, then he’s a hero. And left with those two options, which one do you think he’ll choose?
Third, the Fed has already tapered and FOMC officials’ hawkish rhetoric should accelerate in the coming months. To explain, Citigroup and Morgan Stanley expect a faster-tightening cycle once interest rate hikes begin (expected) in 2022. And on Nov. 17, Citigroup recommended a June 2022-June 2025 eurodollar steeper trade – a position that profits if additional rate hikes are priced into the U.S. yield curve.
“We think that as liftoff gets underway, the slope is likely to increase as some of the uncertainties around the global economy, such as supply-chain bottlenecks, start dissipating,” wrote Citigroup (NYSE:C) strategist Jabaz Mathai.
Currently, swap markets have priced in an 18 basis point rate hike – which is 72% of a typical 25 basis point rate hike – at the Fed’s June 2022 policy meeting. Thereafter, roughly 150 basis points – or six additional rate hikes – are expected by the end of 2025.
However, Citigroup’s trade predicts that the 140 basis points will turn into as much as 240 basis points by the end of 2025 (which implies roughly four more rate hikes than what’s currently priced in). Thus, with inflation now in Biden’s crosshairs, it won’t be surprising if the Fed pivots in the same direction.
Please see below:
Finally, with the Fed and the ECB warning about overvalued assets in their respective financial stability reviews, allowing inflation to sizzle will only increase investors’ bids for any and all inflation hedges. In turn, this will only enhance the stock market’s disconnect from fundamentals, and higher commodity prices will reinvigorate the cost-push inflationary spiral.
As a result, Goldman Sachs CEO David Solomon said on Nov. 17 that the liquidity-fueled circus is likely nearing its end.
“When I step back and think about my 40-year career, there have been periods of time when greed has far outpaced fear. We are in one of those periods. My experience says those periods aren't long-lived. Something will rebalance it and bring a little bit more perspective. And given it feels like inflation is running above trend, chances are interest rates will move up and that will take some of the exuberance out of certain markets.”
The bottom line? While the PMs remain upbeat for now, their fundamental outlooks continue to deteriorate. And while some investors assume that hyperinflation will crash the U.S. economy, policymakers understand this. As a result, avoiding that catastrophe is now on their radar. And while copper and crude have already noticed it, it’s likely only a matter of time before the PMs realize this as well.
In conclusion, the PMs rallied on Nov. 17 and their upbeat attitudes continued to shine through. However, with the fundamental narrative that’s underpinning their strength likely to collapse, their prices should suffer a similar fate. As a result, the medium-term outlook still remains bearish and lower lows should materialize over the next few months.