Thursday, 17 June 2021
A sharp pullback in precious metals prices this week, with gold retreating 5.3% and silver pulling back 6.3% during the US sessions in response to the Federal Reserve’s latest forecast on US interest rates and talk of a potential tapering of their bond buying program. The quote from Fed chair Powell ties in well with last week’s update which covered our theory that inflation is actually much higher in reality than what we see printed in the official CPI: “Inflation has come in ahead of expectations in the last few months. Is there a risk that inflation could be higher than we think? Yes.” “There is a lot of uncertainty. We need to see how things evolve in coming months. This is an extraordinarily unusual time.”
This week we will look at the two competing arguments between precious metals bulls and bears, of whether or not inflation will be a tailwind or headwind for metal prices moving forward. On the one hand, higher inflation generally leads to lower ‘real’ bond yields, which is bullish for gold. But on the other hand, higher inflation should also lead to the Fed tapering its massive bond buying program and raising interest rates – something which can be seen as bearish for gold prices. There is more complexity to the story than that, but the market is currently fixated on these two outcomes, so we will delve into it.
First to gold and silver prices from a technical perspective. We often see gold loving a good ‘false breakout’ below a key level to wash out any weak bulls before reversing, and this could be what we are seeing this week. There was a bit of selling in the lead up to the Fed’s FOMC meeting and that was largely due to traders taking profits on the news of another beat in inflation last week. ‘Buy the rumour, sell the news’ is the old saying and no doubt we saw that in play on the recent inflation print as gold only bounced 0.5% on the announcement before rolling over. There is potential for a false break here of the downtrend line from August 2020, as gold hit a significantly oversold $1,775 level below this key trendline. On a daily chart the Williams% oscillator is signalling -94, which is about as oversold it gets on a daily chart. Certainly, a big washout for both metals, but expect physical demand in Asia to react positively to the lower prices.
Silver’s overall long-term trend remains bullish despite the drop from $28.00 to $26.00, but there remains a bit of uncertainty in the market around inflation, given that traders haven’t seen a period of significant inflation since the 1970s, so you can forgive them for not knowing what to do in the short term. As long as silver puts a low in above $24.00 USD it would continue its recent run of consistent higher lows since the September 2020 low of $21.65.
Back to the FOMC announcement and you can see in the below ‘dot plot’ chart that the Federal Reserve officials are starting to forecast interest rates hikes starting as early as next year. The dots represent a guestimate of each Fed official as to where they think the cash rate will be, and you can see it is a bit of a mixed bag with the majority still seeing rates at close to 0% next year, with a random spread of guesses between 0% and 1.6% for 2023. There is not a great deal of science behind the dot plot really, and a pretty terrible historic track record when you look back at previous years, so it’s a wonder why anyone even pays attention to it.
The Fed also talked about tapering its asset purchases, but it is all talk at this stage, and there is a very good reason why the Fed cannot let rates rise without a complete catastrophe in the US. Powell even made a joke about it, as financial media has been completely fixated on ‘taper talk’ of late.
“You can think of this meeting as the talking about talking about tapering and can I now suggest that we retire that term,” Mr Powell said.
The debt levels of the government, corporates and individuals are so much higher than pre GFC levels that a significant rate hike cycle would obliterate the entire economy in a giant credit crunch that would put the GFC and dotcom bubble to shame. So we get the impression that the Fed is stupid enough to try to ‘talk down’ inflation. Talking about tapering their asset price purchases and raising rates, as if that will bring the next few months CPI numbers lower. But in reality, they are dreaming, and there is nothing they can do to stop a complete catastrophe if inflation continues to gain traction throughout 2021.
The truth of the matter is, the Fed and other central banks have gone too far already. Economies and financial markets are now completely reliant on the trillions of dollars of stimulus put in place over the past decade. This is not something that you can easily reverse. Markets are addicted to free money and ultra-low interest rates, and the credit expansion that has occurred in this environment cannot, and will not, tolerate higher interest rates without a gigantic bust. Inflation will likely be the very thing that causes the prick of the bubble, as not even the CPI can hide the level of inflation we are seeing materialise since 2020.
Those arguing inflation will lead to higher interest rates, which is therefore bearish for precious metals, really need to look closely at the 1970’s period to understand how to position a portfolio in an inflationary environment. Over the long term it is ‘real yields’ that matter, so as long as the inflation rate remains higher than the 10-year bond yield, gold will look like a better alternative to government securities. Even if interest rates go from 0% to 10% in the next few years, if we see inflation move from 4% to 15% in the same time frame the real return on bonds will likely remain negative, and gold will remain attractive. This naturally leads to money flows out of bonds and into gold pushing prices higher and gold could still outperform inflation despite interest rates moving higher.
The only way to hedge your portfolio of property, stocks and bonds during an inflationary period is to have gold exposure. But for now, the market is reacting in a confused manner, undecided as to whether higher inflation is a tailwind or headwind for gold. Eventually the market will work it out when the realisation sets in that the Federal Reserve and other central banks don’t really have any tools to combat inflation without bringing on massive unintended consequences.
The other thing that gold has going for it in an inflationary bust, is the flight to safety aspect. With stock valuations at historically high levels, inflation forcing central banks hands to raise rates will very likely lead to significant volatility in equities, which leads to money flows out of equities and into gold as a safe haven. The Nasdaq tech index is below, and the dotcom bubble looks like a small blip in comparison to today. The stock market is currently pricing in a perfect scenario of strong growth and low inflation, so it won’t take much to upset the party.
One thing we can agree on is Powell’s statement of ‘there is a lot of uncertainty… this is an extraordinarily unusual time”. This statement really sums it up. It is hard to imagine a more uncertain period in many of our lifetimes, so it is prudent to position for any and all possible scenarios. Right now volatility in precious metals prices is reflecting the uncertainty of US investors as they race to position themselves for the unknown effect of higher inflation. History never repeats exactly but it does rhyme, so we would see this period of market uncertainty as an opportunity and have confidence that over the longer term if inflation is here to stay, it would much more likely benefit precious metals prices than it would over indebted companies, individuals and governments who cannot afford to pay higher interest rates on the unprecedented debt levels built over the past two decades.
Until next week,
John Feeney
Guardian Gold Sydney
If you have any feedback or questions about this report, you can contact John Feeney direct at johnf@guardianvaults.com.au
Or on Twitter @JohnFeeney10
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