Contributed Commentaries
Stagflationary fears heat up heading into Fed week
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
After the Western world began to wage a financial war against Russia last week, Gold Futures ran towards its record peak resistance at $2089 on Tuesday, coming just $20 short of this major milestone. But the safe-haven metal became extreme overbought in the short-term while doing so, ushering in a healthy consolidation of its out-sized gains.
Russia's economy has been crumbling in the face of harsh sanctions that have targeted its economy and financial system. The sanctions have included freezing hundreds of billions of dollars' worth of the central bank's foreign currency assets and blocking Russian banks from the international SWIFT payments system.
According to an early morning report from Bloomberg on Wednesday, Russia's fiat currency sank 11% to 117.7 per dollar. The latest drop means the ruble has fallen nearly 40% so far this year, to historic lows, and is worth less than a penny.
This week, in an effort to block one of Moscow's remaining possible avenues for offsetting the recent collapse of its currency, U.S. lawmakers proposed a bill targeting Russia's $132 billion in gold. Senators also aim to include the gold sanctions in the omnibus spending package that could pass as soon as this afternoon. The legislation would also apply restrictions on American entities making gold transactions with Russia's central bank holdings.
Western lenders are already barred from transacting with the Russian central bank, effectively cutting its gold out of the biggest markets in New York and London. Once this bill is signed into law by President Biden, the upside potential in gold is more than just a safe haven hedge, as the rising geopolitical tensions and the latest sanctions imposed on the Russian central bank will likely have other central banks around the world to reconsider their FX holdings, and start shifting towards "no counterparty risk" gold.
Historically, geopolitical turmoil has been a short-term driver when moving the gold price to extremes in a short period of time. Geopolitical catalysts rarely last in the longer term for gold, however, the war in Ukraine is having a greater impact on the global economy and financial system that has seen global debt rise to over $300 trillion last month.
The U.S. Federal Reserve Bank is about to begin a long-overdue rate-hiking cycle in an effort to bring down inflation that rose to 7.9% YoY in February, up from 7.5% in January. Although Fed Chairman Jerome Powell testified before congress last week that "Hindsight says we should have moved earlier," the world's largest central bank is "inclined to support a 25-basis-point rate hike" at the Fed's policy meeting next week. There had been earlier speculation of a bigger, half-percentage-point hike.
The Fed not moving earlier has quite obviously put the central bank well "behind the curve" due to the fact that the Fed spent all of 2021 trying to convince the markets that inflation was "transitory", instead of taking measures to ensure that inflation did not stray too far from its 2% target.
Moreover, bond markets are flashing a warning signal about the growth prospects for the global economy. The gap between long-term and short-term government borrowing rates in large developed economies has narrowed drastically since mid-October. Just as the world's largest central bank prepares to tackle soaring inflation with higher interest rates, the yield curve is already dangerously close to inverting before the Fed is expected to begin its rate-hike cycle on March 16th.
An "inversion" of the yield curve has preceded every U.S. recession for the past half century. With the U.S. economy already becoming dangerously close to entering recession, commodities have soared across the board as the war in Ukraine rages on after a fourth round of peace talks ended without any agreement this week.
As the Fed is about to begin to take away the punch bowl, the economy has already been decelerating from the unprecedented $3.6 trillion in federal pandemic spending. White House estimates in President Biden's 2022 budget proposal shows gross domestic product (GDP) growth projections slowing from over 5% in 2021 to less than 2% by 2024 and beyond.
Moreover, other major central banks are also increasingly concerned about inflation as well. With the larger ones recently giving out signals that they will not let inflation run too hot, even if it means a slower growth. ECB President Christine Lagarde announced on Thursday that the central bank is ready to take ‘whatever action is needed to pursue price stability and to safeguard financial stability' in Europe.
In its latest economic projections, the ECB said that GDP is expected to expand 3.7% in 2022, down from the previous forecast of 4.2% growth. Economic activity is expected to increase 2.8% next year, down from the prior forecast of 2.9%. The economy is expected to grow just 1.6% in 2024, unchanged from the previous forecast.
In June of 2020, I wrote about the very real possibility of stagflation entering into the global marketplace at some point in the near-future. The main economic theory of stagflation is that the confluence of a stagnant economy and inflation are results of a poorly constructed economic policy. Recent soaring commodity prices in the face of a slowing economy have placed major central banks in a very difficult position, as the slowing economy combined with rising inflation is likely to lead to stagflation for the first time since the 1970's.
Judging by commodity price charts across the board, which are at, or near, record highs, this inflationary cycle is likely to last for quite some time. Sharply rising inflation lasted for an entire decade during the 1970's, while the gold price went from a fixed price of $35, after the gold standard ended in 1971, to a peak of $850 in January of 1980. It was a great time to be invested in commodities that rose sharply along with interest rates, but not good for stocks and bonds.
The Fed was able to hike rates to an incredible 20% in the late 1970's that eventually put the inflation genie back in the bottle by the late 1980's. Whereas the Fed could hike rates substantially in the 1970's, it cannot do so this time because of the unprecedented debt. The $30 trillion U.S. national debt, of which 70% is accumulative interest payments, is at 125% of GDP now. By the time Federal Reserve Chairman Paul Volcker raised the Fed Funds Rate to 20% in January of 1980, the U.S. national debt was $900 billion at only 34% of GDP.
More recently, the Fed has launched three rate hiking cycles over the past quarter century and each one has ended in huge losses for the S&P 500, while the gold price made sharp gains each time. And with the Nasdaq reaching official bear market territory earlier this week, gold continues to show relative strength to the stock market.
Smart money has been rotating some of their huge tech profits into the gold complex since the beginning of the year. Bullion is also benefiting from the sell-off in cryptocurrencies. Last year, many younger investors had pivoted to bitcoin, which they viewed as "digital gold." But these investors have recently come to realize that crypto is a form of high-risk speculation, not a store of value. Since making a double-top in November, the price of bitcoin is down over 40%, while the gold price is trading near all-time highs.
Looking at the bigger picture, gold has created a significant 12-year cup and handle pattern, which would be completed once the $2100 level has been breached on a monthly closing basis. There are not too many examples of a multi-year cup and handle pattern in the major markets, and investors should understand how bullish this pattern can be when it occurs over a long period of time. The current cup and handle pattern in gold projects to a technically measured upside target of around $3,000.
Meanwhile, precious metals miners have been rising along with the gold price, while the higher-risk junior gold stocks have lagged. Last week, the GDX technically completed a strong 6-month base after closing above previous resistance at $35, which is now support. But many small-cap juniors have yet to join the miner party, presenting investors a literal golden opportunity to accumulate a basket of quality junior developer/explorers before doing so.
As I type this missive, it appears as though the GDXJ will be making a weekly close above critical resistance at $47 later today. Once we see a weekly close above this important level in the junior miner ETF, I expect sector professionals to begin rotating some miner profits into beaten-down, undervalued quality juniors.
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