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Gold holding key support during panic selling event in stocks

Commentaries & Views

Aggressive central banks have replaced war concerns as the center of gold investor's attention recently, amid a soaring U.S. dollar and sharply rising U.S. Treasury yields. Heading into yet another all-important week of major central banker policy meeting's that began with FOMC meeting conclusions being announced mid-week, the gold price tested support at $1850 on Tuesday.

The Fed on Wednesday raised its benchmark overnight interest rate by a widely expected half-a-percentage point, as it seeks to tighten pandemic-era monetary policy without creating a recession. Although the 50-basis point hike was the biggest in 22 years, investors cheered once the world's most powerful central bank Chairman, Jerome Powell, made an unexpected dovish statement during the following press conference.

"A 75-basis-point increase is not something the committee is actively considering," Powell told reporters Wednesday. "[We are moving] policy rate expeditiously to more normal levels. Additional 50bps increases should be on the table at the next couple of meetings. We'll make our decisions meeting by meeting as we learn from incoming data. The overarching focus is ... to bring inflation down to our 2% goal."

The statement began a huge short-covering move in the gold price, along with most everything else, as whipsaw trading action has been commonplace since the war in Ukraine began in late February. During what turned out to be a brief "buy the news" bounce, the safe-haven metal climbed sharply back over the $1900 level into the next major central bank policy meeting the following session.

However, marketplace uncertainty and nervousness quickly returned once the Bank of England (BoE) raised interest rates to their highest level since 2009 at 1% on Thursday to counter inflation now heading above 10%, even as it sent a warning that Britain risks falling into recession.

By the fourth quarter, The BoE's Monetary Policy Report (MPR) stated the recent surge in UK prices is set to erode British citizen's disposable income enough to trigger a contraction, which could extend to another quarter. The rest of the report also consisted of dire warnings.

Although the Federal Reserve stated it remains content with the U.S. economy and seems confident of orchestrating a "softish landing," the BoE was much less sanguine and minced no words in preparing investors for a likely recession.

With the BoE issuing warnings of an outright recession, investor's concern was re-introduced regarding a near-term U. S. recession despite Fed Chairman Powell's reassurance on Wednesday of the world's most powerful central bank being confident of "using their tools" to prevent one.

The standard definition of a recession is two successive quarters of negative GDP growth. The U.S. received the first one last week with the report that first quarter GDP fell -1.4, which followed the strong 6.9% growth in 4Q 2021 and established that we are firmly in a "stagflationary" environment. One more quarter of negative growth would signal a recession, which suggests that we may already be halfway there.

The news hit stocks hard in pre-market trading yesterday, while the gold price received safe-haven bids. But not enough to hold the $1900 level throughout Thursday's session as the U.S. dollar zoomed to fresh 20-year highs, along with U.S. 10-year Treasury yields surging to 3.09% and reaching the highest level since 2018.

All eleven sectors closed in the red on Thursday as stocks totally reversed Wednesday's Fed relief rally. The Dow Industrials fell over 1,000 points and closed down over -3% after meeting resistance at its 50-day moving average. The other two major indexes experienced bigger percentage losses.

The S&P 500 lost nearly -3.56%, and the Nasdaq was the day's biggest percentage loser with a -5% loss. The big jump in bond yields took a larger toll on technology stocks and the Nasdaq market as the 10-year T-bond yield is up 1.44 percentage points since the start of the year.

With panic selling returning to the marketplace on fears of a Fed-induced recession, this begs the question at what point does the central bank reverse its tightening policy this time? Over the past four decades, policy interest rates have topped out at progressively lower levels during Fed monetary policy tightening cycles, and eventually pushed the economy into a recession each time.

In 2000, the federal-funds rate peaked at 6.5%; in 2006, it peaked at 5.25%; and in 2018, it peaked at 2.5%. And with U.S. government debt at over $30 trillion, the interest alone at a 2% rate would likely be $1 trillion.

If the Fed fulfills its dot-plot suggestion of 50-basis point rate increases after each of its next two policy meetings, the federal-funds rate is expected to be 2% by late July. And if past is prologue, the U.S. central bank may be forced to reverse course by then if Q2 GDP comes in negative a day after the July 27th FOMC meeting concludes.

It is becoming clearer that investors are losing more confidence in the world's most powerful central bank's failed monetary policy. Fed officials began signaling around November that they no longer expect inflation to be "transitory" in the pandemic era. Then by March, Fed Chairman Jerome Powell raised the policy rate for the first time in four years, while saying inflation at 40-year highs might not return to pre-pandemic levels for several years.

Meanwhile, despite the longer-term macro fundamentals being bullish for the entire gold complex once the Fed is forced reverse course yet again, gold stocks are also being sold as marketplace deleveraging continues. During panic selling events, margin clerks become more powerful than irresponsible central bankers.

With the miners and silver continuing to show relative weakness to the gold price, both GDX and GDXJ have been trending lower with stocks during deleveraging marketplace selloffs since mid-April. The miner ETFs are in the process of forming bear flags after selling down sharply below support levels at $35 and $43 respectively earlier this week. If we see weekly closes below these levels later today, the next areas of support are at $33 in GDX, and $40 in the higher-risk GDXJ.

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