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Peak Fed hawkishness sparks gold short squeeze

Commentaries & Views

As telegraphed in this space last week, the gold complex was set up for a sharp move heading into this week’s Federal Open Market Committee (FOMC) meeting results. At the conclusion of the FOMC meeting on Wednesday, the Fed announced an expected second consecutive rate hike of 75 basis points (bps), bringing the Fed funds rate to a range of 2.25 to 2.5%.

This second consecutive large move signaled the world’s most powerful central bank’s strong commitment to bring inflation to its 2 percent target, anticipating further tightening in the months ahead. The last time the Fed raised rates by 150 bps after two straight meetings was at the beginning of the 1980s, when Paul Volcker was the Chairman of the U.S. central bank.

With the move already expected by the market, the gold price did not react much until the Fed Chair Jerome Powell press conference began thirty minutes later. Shortly after the televised event began, Powell provided the necessary spark required to provoke a strong short-covering rally in the gold price.

Once Powell mentioned the Fed is leaning towards normalizing rates as soon as early 2023, the gold price moved briskly towards initial resistance at $1740. Powell also said Wednesday that the central bank would be prepared to slow the pace of rate hikes as the economy reacts to its aggressive monetary policy. While the Federal Reserve is expected to continue raising interest rates into year-end, the price of bullion immediately began to reflect the marketplace moving from peak hawkishness.

Yet, the most telling highlight of the press conference came when Powell emphatically stated several times the economy was not currently experiencing recession, as this statement came a mere 16 hours before Q2 Gross Domestic Product (GDP) data revealed otherwise.

On Thursday morning, the Commerce Department said in its advanced reading that U.S. GDP fell -0.9% in the second quarter, missing market estimates by a wide margin of a 0.4% increase. The disappointing news came after Q1 GDP was announced at -1.6% in May. Commonly, a recession is understood as two consecutive quarters of GDP contraction.

It isn’t readily clear when or where the idea that two quarters of negative GDP growth equals a recession originated, although in almost every case, the adage is true and it has, historically, been a reliable recession indicator.

Moreover, all of the past 12 recessions identified by the National Bureau of Economic Research have seen at least two quarters of negative GDP growth, and, conversely, each instance of at least two quarters of negative GDP growth has later been declared a recession.

But government economists recently claimed that is not the official definition of a recession, nor an appropriate one, after the White House changed the official definition of a recession earlier in the week. From a White House blog post on July 21, the government now says that data from every facet of the U.S. economy must be considered and foreshadows what to expect for Q2.  

Nevertheless, the gold price continued its climb towards stronger resistance at $1780 after the consecutive negative quarterly GDP announcement yesterday. Historically, bullion outperforms by a whopping 50% on average in a two-year period that covers 12 months before, and after a recession.

Meanwhile, the relative strength of junior precious metals equities, along with the silver price, continues to bifurcate higher from both gold and its miners. Both higher-risk junior ETFs (GDXJ & SILJ) closed higher last week after five consecutive weeks in the red.

Then on Thursday, the gold and silver junior ETFs broke out above the neckline of their respective reverse head & shoulders bottoming patterns on a daily basis with rising volume, heading into the last trading session of the month on Friday. A weekly close above $35 in GDXJ with convincing volume would bring stronger technical evidence of a significant bottom being struck in the junior complex.

Additionally, the closely watched gold/silver ratio has printed a bullish island reversal pattern on its weekly chart. Higher-risk silver and junior precious metals stocks generally lead the gold price in either direction, while a move below 80 in the gold/silver ratio would be bullish for the entire sector.

Conversely, the GDX remains in its downtrend after Newmont Corp (NEM) tumbled 13% to begin the week on warnings about soft metal prices and inflation concerns in its Q2 release on Monday morning. The world’s largest gold miner constitutes nearly 13% of the global miner ETF, being its largest holding. Further out, a weekly close above $30 in GDX is required for technical evidence of a significant bottom being struck in the precious metals mining complex.

As we head into the close of the last trading session of July later today, the gold price is holding on to solid gains after the just released Personal Consumer Expenditures (PCE) showed an increase of 4.8%, up from last month’s reading at 4.7%. The core inflation strips out volatile food and energy prices and is the Fed's preferred inflation measure.

After a brutal 13-week decline of 45% in GDXJ, many quality junior gold stocks have already moved up double-digits over the past few weeks, while others are showing signs of following suit. Last Friday, the Junior Miner Junky (JMJ) subscription service telegraphed a purchase of two junior gold developers to its members before Fed-speak Wednesday. Both stocks have moved up over 15% after the opportunity was presented to JMJ members.

The Junior Miner Junky (JMJ) service is completely transparent, which assists in teaching its members how to construct and maintain a successful junior resource stock portfolio. Subscribers are provided a carefully thought-out rational for buying individual stocks, as well as an equally calculated exit strategy. JMJ also teaches subscribers how to navigate the high-risk junior resource equity sector by incorporating proper risk management tactics. If you would like to receive my research, newsletter, portfolio, and trade alerts, please click here for instant access.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.