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Gold consolidating recent gains at $2000 into Fed week

Commentaries & Views

Demand from investors seeking a haven against weakness in stocks and bonds, as well as geopolitical turmoil in the Middle East, has been pushing both gold and the U.S. dollar higher. December Gold Futures are bullishly consolidating recent outsized gains near the key $2000 level heading into the weekend.

With the S&P 500 losing key support at 4200 mid-week due to escalating war fears, government dysfunction, and rising bond yields, we could be setting up for an unsettling Fed-week.

The continued surge in bond yields is now supporting gold, as traders and investors grow increasingly concerned about U.S. fiscal policy, and whether the recent jump in both real and nominal yields will eventually "break something."

One of the main reasons why yields on long-term Treasuries have been going up is investors are concerned about the growing amount of U.S. debt now over $33.6 trillion, while parabolically rising $40 billion per day at the current rate.  

The U.S. 10-year note recently hit 5%, while the 20-year bond and the 30-year bond now exceed 5%. This has pushed up mortgage rates, which are now at around 8%. In turn, this puts pressure on home buyers who need to remortgage.

The cost of borrowing to buy a house has risen even as the Federal Reserve is likely to keep its inflation-fighting rate-hike campaign on pause next week, after lifting its benchmark policy rate from near zero in March 2022 to 5.25-5.50% in July of this year.

The market has come to rely on the Fed stepping in with a rescue plan when things fall apart, which has kept stocks priced for perfection. Investors have been taught ever since Black Monday in 1987 that the Fed and the Treasury will team up to step in and save the market during major declines. After they bailed out the entire U.S. banking system in late 2008, the price of gold doubled by September 2011.

While the Federal Reserve and U.S. Treasury will likely be required to team up yet again to step in and save the market with stimulus measures at some point, China is already doing so. The People's Bank of China (PBoC) has now added a whopping $268 billion in short-term stimulus into the world’s second-largest economy over the past week alone.

This bold policy move to rejuvenate its economy is a very rare occurrence, and one of the largest cash injections in the history of the PBoC. The last time China rolled out similar fiscal policy measures was back in 2008, along with the Fed bailing out U.S. banks, and this latest injection could be just the beginning.

Meanwhile, Middle East worries, chaos in the U.S. government, and rising bond yields are creating uncertainty and offsetting any good news on the economic front as we head into the next FOMC meeting on Oct 31-Nov 1.

So far, the U.S. is not experiencing much weakening in economic numbers after home sales, an advanced Q3 GDP reading, durable goods, and weekly jobless claims all came in better than expected this week. There have been layoffs announced at some institutions, but jobless claims remain in ultra-low territory.

Yet, consumers probably cannot keep spending at the current pace since their incomes are barely rising faster than inflation. Businesses are proceeding cautiously because of higher borrowing costs, while banks are more reluctant to lend.

Other restraints on the economy include higher gasoline prices and a surge in long-term interest rates that make it far more expensive to buy houses, cars, appliances, and basic living expenses.

While the market poured over GDP data that came in slightly stronger-than-expected at up 4.9% on Thursday, what matters more is the current quarter. Already, there are worrying signs, from bank lending to cautious corporate commentary.

Ignoring the gyrations after COVID, and the last time the economy grew at least 5% then was negative the next quarter, was 1981, when GDP was up a frothy 8.1% in the first quarter and then contracted 2.9% in the second quarter.

The economy grew at a solid 2.5% pace right before the 2007-2009 Great Recession, and GDP grew 4.4% in the first quarter of 1990 just several months before a recession started. Many of the same economic headwinds are still in place that led to widespread Wall Street predictions of recession earlier in the year, with Middle East war fears being added to investor concerns.

In the more than 60 years covered by this chart, the Leading Economic Indicator (LEI) has never suffered a peak-to-trough decline of 10.5% without the economy having entered recession. And the LEI has never declined for longer than 20 months from its peak without the economy having entered recession.

Assuming that the economy is not in recession today (a reasonable assumption given the recent data), this implies that with respect to the LEI’s messaging the economy is now in uncharted territory.

Business and consumer confidence is also trending at its lowest levels since the Great Recession of 2007-2009 and the steep recession of 1980–1982. Interest rates are rising at the long-end of the curve. This is narrowing interest rate spreads as the closely watched 2-10 spread is at its narrowest in some time and suggests that a recession is getting closer.

If the current cycle ends up being unprecedented in terms of the time from leading indicator warnings of recession to the actual start of a recession, I would expect that it will be due to the federal government doing aggregate-demand-boosting spending much sooner than usual during the cycle. This could delay the start of a recession to beyond the historical range, but only by creating the conditions for a government debt spiral.

Taking all of this into account, closing in on an expected breakout to all-time highs above $2100 may have stimulated some rebuilding of Western institutions' depleted gold positions. Recent data shows that along with speculative momentum, long-term investors are starting to jump into the market and buying gold-backed exchange-traded products.

SPDR Gold Shares (GLD), the world's largest gold ETF, saw its holding increase by 15 tonnes last Friday as prices spent most of the session above $2000 per ounce. Yet, 400+ more tons of buying is needed to get back to the GLD level from three years ago.

Moreover, the gold price began to outperform the stock market as war in the Middle East intensifies, with the Gold/S&P ratio rising to test the key 0.50 level this week. The market feels like cracks are starting to form in the dam and once this important level is breached, the flight out of equities and into the safety of gold could very well take this ratio back up to 1 share of the S&P being equal to 1 ounce of gold like we saw from early 2010 until 2013.

Given that the U.S. currently adds $40 billion to its nearly $34 trillion National Debt each day with no ceiling; has a non-functioning legislative branch of government; a leading Republican contender for the 2024 presidential election who is facing 91 criminal felony counts; a deadline to fund the U.S. government approaching on November 17 with a new House Speaker who is an avowed supporter of Trump; a war raging in the Middle East and another in Europe; and credit rating agencies scrutinizing ratings on the biggest U.S. banks – perhaps this is reason enough for Western investors to finally begin rotating some of their profits from a priced for perfection stock market into GLD.

I expect the miners to begin outperforming the stock market once 0.50 resistance on the GOLD/S&P500 ratio becomes a floor (possibly concurrent to when all-times highs above $2100 are achieved) followed by the juniors, which should then outperform both.

In anticipation of the incredible gains the junior sector should begin to experience once the gold price prints a technical breakout above $2100, the Junior Miner Junky (JMJ) newsletter has accumulated a basket of quality juniors with 3x-10x upside potential into 2025-26.

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