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Gold nears breakout after the Fed signals an end to rate hikes

Commentaries & Views

After witnessing the 2nd and 3rd largest bank failures in U.S. history happening back to back, depositors withdrew a total $42 billion from U.S. banks last Friday. In contrast, the precious metals market recorded a net inflow totaling $5.9 billion, which was the second largest weekly inflow into the safe-haven sector since the 2008 global financial crisis.

Gold Futures blew through the key $2000 level by early Monday morning as the financial contagion spread to Europe. Over the weekend, UBS agreed to buy troubled rival bank Credit Suisse on Sunday in a state-backed takeover for 3 billion Swiss francs ($3.23 billion) and assume up to $5.4 billion in losses. This shotgun merger engineered by Swiss authorities amounts to a commitment of a third of the country's GDP to rescue its banking system.

In a global response not seen since the height of the pandemic, the Federal Reserve said it had joined central banks in Canada, England, Japan, the EU, and Switzerland in a coordinated action to enhance market liquidity.

Banks continued to borrow from the Fed at historic levels approaching the 2008-2009 financial crisis in the past week. Banks also borrowed $53.7 billion under the Bank Term Funding Program, the freshly created lending program by the Fed to offer more cash at generous terms.

Meanwhile, with Fed-heads on blackout until the FOMC meeting concluded on Wednesday, it was up to U.S. Treasury Secretary Janet Yellen to soothe financial panic during the American Bankers Association conference in Washington. Yellen said on Tuesday the U.S. government could repeat the drastic actions it took recently to protect bank depositors if smaller lenders are threatened.

“Our intervention was necessary to protect the broader U.S. banking system, and similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion,” Yellen said in prepared remarks.

Yellen also made a point of contrasting recent bank failures with the wider crisis that threatened many large institutions and credit markets in 2008. “Recent developments are very different than those of the global financial crisis,” she said. “Back then, many financial institutions came under stress due to their holdings of subprime assets. We do not see that situation in the banking system today.”

Miss Yellen is correct in her assessment of the current crisis being “very different,” however, the “situation in the banking system today” has the potential to be far worse than in 2008. Although all banks did not feed excessively at the subprime asset trough beginning at the turn of the century, which precipitated the great financial crisis of 2008, every bank has taken advantage of yield curve activity into the recent rate hike cycle.

While money was too cheap, with artificially low interest rates since 2008, it was a no-brainer for all banks to place reserves into the long-term for the best yield. With interest rates being held too low for far too long, this also allowed the U.S. government to increase its parabolically rising debt to nearly $32 trillion.

This extended low interest rate environment influenced the banking industry to take demand deposits, which were virtually free money, and buy long-term debt to capture the greatest spread for profit. When depositors became afraid of banks going bust, they withdrew deposits which forced banks to sell its U.S. Treasuries for cash at a loss when the yield has risen higher than the paper yield they bought.

Now that rates have risen so quickly, the banking system is in turmoil due to the Fed Funds Rate (FFR) going from zero to 4.75% in just one year's time. Not to mention the debt ceiling standoff in Washington that will come to a head in June, when U.S. Treasury Department gimmicks to extend government funding will likely be running out.

The massive over-spending unleashed by the U.S. government has undermined our banking system once again, with bank failures highlighting the underlying fragility of fractional reserve banking. The consequences of the Fed's most aggressive rate-hike campaign in over 40 years, which began last March, came home to roost heading into the highly anticipated FOMC meeting on Wednesday.

Although the Federal Reserve announced an expected 25 basis point rate hike in the FFR to a target range of 4.75%-5.00% mid-week to save face, Fed Chairman Jerome Powell also signaled an end to rate hikes being not far off. Powell said the central bank no longer believes that “ongoing rate increases will be appropriate to quell inflation” –replacing that language with, “Some additional policy firming may be appropriate.”

Despite banks continuing to borrow around levels last seen during the 2008 great financial crisis, Powell insisted that America's banking system remains “sound and resilient” but acknowledged that some conditions would change. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the Fed Chairman said.

The management of Silicon Valley Bank "failed badly," Powell mentioned in the press conference after the Fed's policy meeting speech on Wednesday. Then added, "These are not weaknesses running broadly through the banking system."

On the heels of the 0.25% interest rate hike by the Federal Reserve, gold began to price in an end to higher interest rates by zooming towards all-time highs after having already done so in most other major currencies earlier this month. And as I type this column, Germany's Deutsche Bank shares are tanking early Friday as the cost of insuring against its default rose.

With the light at the end of the gold tunnel no longer being an on-coming train of higher interest rates, a historic monthly/quarterly close above $2000 in the world's reserve currency next Friday has now become a very real possibility.

The sharp move higher into January was gold's third test of broader resistance at $2000 per ounce, while the safe-haven metal has yet to close above this key level on a monthly basis. Following a healthy 50% correction of the 3-month $355 gain, gold is in the process of making a fourth attempt to breakout into new all-time highs. After the gold price broke out above the psychological $1000 level on its fourth try in mid-2009, its price had nearly doubled by late 2011.

The banking turmoil placing the Fed on a collision course between its inflation/employment mandate vs. its role of maintaining financial stability influenced the gold price to close at a 52-week high last week. In fact, bullion is trading at a 52-week high in relation to stocks, bonds, oil, commodities, and most importantly bank stocks.

With the gold price moving towards a possible monthly/quarterly close above $2000 next Friday, precious metals stocks have plenty of catching up to do if this historic event takes place. When gold was threatening the $2000 level a year ago, the GDX was trading 25% higher than it is today. And with fuel being up to 50% of mining costs on average, the oil price has been cut in half since then as well.

It is not hard to imagine that after 15 years of zero-interest rate policies (ZIRP), most portfolios may not have been constructed to survive a generationally quick shift in interest rates, not to mention having zero exposure to gold equities.

In fact, institutional investment portfolios in totality have a small percentage of assets allocated to precious metals at less than 1%. Just a 2-3% allocation of their assets into the relatively tiny precious metals sector, would be accompanied by soaring prices in mining stocks. By the time the marketplace begins to price in a gold price floor of $2000 per ounce, which has been strong resistance for over a decade, a speculative frenzy in junior mining stocks will not be far behind.

Before the precious metals sector comes back into favor, it is best to accumulate full positions in select quality juniors ahead of the coming herd of momentum trader's and institutional investors. With the gold price now outperforming everything that was responsible for keeping generalist investors out of this battered sector over the past decade, the largely forgotten junior complex is poised to explode higher when $2000 likely becomes the new floor later this year.

In anticipation of the incredible gains the junior sector should begin to experience once the gold price has a solid $2000 floor, as opposed to a 13-year ceiling, the Junior Miner Junky (JMJ) newsletter has accumulated a basket of quality juniors with 3x-10x upside potential into 2025-26. If you require assistance in accumulating the best in breed precious metals related juniors, and would like to receive my research, newsletter, portfolio, watch list, 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.