The road to stagflation is being paved with gold
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
The term "stagflation" was first used in the United Kingdom by politician Iain Macleod in the 1960’s, while he was speaking in the House of Commons. At the time, MacLeod was talking about inflation on one side and stagnation on the other, calling it a "stagnation situation." It was later used again to describe the recessionary period during the 1970’s following the oil crisis, which fueled the gold price to soar from $35 in 1971 to $850 per ounce by January of 1980.
The main economic theory of stagflation is that the confluence of stagnation and inflation are results of a poorly constructed economic policy. Rising taxes in the Eurozone has increased the cost of doing business and is causing prices to rise. However, they have been rising only because of higher costs and not demand.
Therefore, you have rising prices in the EU defined as inflation but without the economic growth or demand, creating a breeding ground for stagflation. This was already instigating rising civil unrest before the lock-downs took place, as the standard of living has been declining with the net disposable income.
According to U.S. Labor Department data published on Wednesday, the official annual U.S. inflation rate is at 0.1% for the 12 months ended May 2020, as compared to 0.3% previously. The so-called core rate of inflation, which strips out volatile food and energy prices, also fell 0.1% and marked the first time the core rate has fallen three months in a row. But these statistics do not represent necessities purchased by the average person, as the things people need have been going up, while the economy has stagnated and the government continues to tell us there is no inflation.
As the coronavirus pandemic drags on, absolute necessities are getting more expensive while the things we can forgo have become cheaper. Things that we are still spending money on, like rent, food, alcohol, and video streaming, are going up in price. But things we are buying less of, like gasoline, clothing, transportation and hotel rooms, are going down in price.
In May, grocery prices rose 1% compared with April and over the past three months, they’ve risen 4.1% which is an annual rate of 17.5%. And beef prices alone are up 11% in just three months. When combined with both rental and ownership costs being up 2.6% in the past year, compared with a 0.9% drop in the prices of everything else, the U.S. has been experiencing stagflation for the past few months.
Due to global government lock-downs being enforced to combat the COVID-19 pandemic, we have experienced a demand-side economic collapse led by the contraction of consumer spending. This immediate collapse in the economy has been responsible for a supply-side shock in which goods and services we need to survive have become more expensive due to shortages.
After the 2-day FOMC meeting concluded on Wednesday afternoon, all ears were awaiting to hear what the Federal Reserve had to say regarding monetary policy. There were no surprises, as Fed Chairman Jerome Powell remains committed to keeping interest rates near zero until at least the end of 2022, while using all the central bank’s tools necessary to support the economy.
However, during a virtual press conference following the conclusion of the FOMC meeting, Powell gave investors a dose of economic reality. The Fed chairman said it's basically impossible to try to figure out the short-term path of the economy and that the road to recovery will be a long one. Pointing to the May jobs report showing a 2.5 million increase in employment, he said it was "probably just the biggest data surprise ever."
When asked about when the Fed expected to begin raising interest rates, the uber-dovish sounding head of the world’s largest central bank stated "We're not thinking about raising rates, we're not even thinking about thinking about raising rates." This was music to gold’s ears and investors began selling equities, while rotating some of those profits into gold. This brought the safe-haven metal back to an upward bias inside its 10-week bullish flagging pattern, building a stronger base before possibly taking on multi-year resistance at $1800 in Q3.
Moreover, the Fed reiterated its commitment to continue increasing its balance sheet by at least the current pace for the next few months, which has already ballooned past $7 trillion. The Fed will be purchasing $80B worth of Treasuries and $40B of agency mortgage-backed securities (MBS) by the end of the year, as well as $250–500M per week of agency commercial MBS.
Powell also appealed for Congress to step up with further fiscal support and stimulus during the press conference. Treasury Secretary Steven Mnuchin followed up on this plea Thursday, when he signaled the Trump administration could be open to providing another round of stimulus check’s to Americans as he spoke at a Senate hearing about what may go in Washington’s next coronavirus aid package.
The Fed chairman even hinted the September meeting could reveal more regarding date-based forward guidance, front-end yield curve control (YCC), and/or an explicit definition of the asset purchase program. Earlier this week, billionaire hedge fund manager Jeffery Gundlach told Bloomberg that should the 30-year Treasury rate -- which is now hovering near 1.6% -- move above 2%, the Fed may introduce YCC to force yields lower.
Ole Hansen, head of commodity strategy at Saxo Bank, told Kitco earlier this week that gold prices stand on a knife’s edge as focus shifts to bond yields. Hansen noted that yield curve control from the Federal Reserve would be a game changer for gold and added that this move by the U.S. central bank could be the trigger gold needs to break out of its current range.
With real interest rates going more negative, as well as increased geo-political tensions, I expect the gold price to remain well bid. Continued ultra-easy global monetary policy and the potential for YCC by the Fed will also keep the reflation trade intact and the U.S. economy showing further signs of stagflation.
Meanwhile, the GDX ran up to its downtrend line after Fed-speak, then reversed the following session and remains inside a mild consolidation of recent gains. After rising more than 130% in just a few short months, the global miner ETF is taking a well-deserved break. The GDX tested its breakout of a 7-year base inside the $30-$32 region last Friday, which has resulted in a 17% correction thus far from its recent multi-year high of $37.49 in mid-May.
Wall Street tumbled in a broad sell-off on Thursday, with the Dow plunging nearly 7% on rising volume and gold stocks saw more profit taking as well, with the GDX testing its 50-day moving average on continued low volume. This corrective sell-off in the mining space is creating another buying opportunity in recently cashed up developer/explorers who are in the process of de-risking high-margin projects.
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