While silver remains in the Christmas spirit, the holiday cheer may not last much longer.
After a major short squeeze helped propel the silver price higher on Nov. 30, the white metal closed above its 200-day moving average. However, with liquidity-fueled assets leading the charge, dramatic declines should materialize when the bullish seasonality reverses in January.
Please see below:
To explain, the gray, red and green lines above track the silver futures price, the Bitcoin futures price and the ARK Innovation ETF (ARKK). If you analyze the vertical gray line on the left side of the chart, you can see that the chase was on shortly after Powell spoke.
But, with liquidity-fueled assets like silver benefiting from lower interest rates and looser financial conditions, that’s the opposite of what the Fed needs to curb inflation. Therefore, while Powell reminded us that a hot labor market is at odds with his 2% inflation goal, the ‘QE kings’ are behaving as if real rates are negative and the Fed’s balance sheet is accelerating
In contrast, Powell said on Nov. 30:
“I think for now we have to assume,” that labor supply won't rebound. “We have to do what it takes to restore balance in the labor market to get back to 2% inflation… by slowing job growth rather than putting people out of work.”
For context, Powell was being diplomatic when he said he wanted to avoid “putting people out of work.” Of course, he does. It’s not the Fed’s goal to crash the U.S. economy. Yet, the reality is that the Fed is unlikely to cool ~40-year high inflation with a ~50-year low unemployment rate.
Please see below:
To explain, the red line above tracks the U.S. unemployment rate, and the vertical gray bars mark U.S. recessions. As you can see, the unemployment rate always hits a cycle low before rising sharply. Furthermore, no Fed committee in history wanted to put people “out of work,” but for inflation to fall, the U.S. unemployment rate must rise.
Consequently, with resilient growth, inflation, employment and consumer spending not cooperating right now, the Fed needs to push the FFR much higher, and a realization is bullish for real yields and the USD Index.
For example, the Fed released its latest Beige Book on Nov. 30. For context, the report consolidates all of the results from the regional Fed banks, so it’s akin to a nationwide survey. An excerpt read:
“Consumer prices rose at a moderate or strong pace in most Districts… Inflation was expected to hold steady or moderate further moving forward.”
In addition:
“Employment grew modestly in most districts, but two Districts reported flat headcounts and labor demand weakened overall. Hiring and retention difficulties eased further, although labor markets were still described as tight….
“Wages increased at a moderate pace on average, but a few Districts experienced at least some relaxation of wage pressures. Opinions about the outlook pointed to stable or slowing employment growth and at least modest further wage growth moving forward.”
Thus, with output prices rising at a “moderate [to] strong pace,” while employment and wages increased at a “moderate pace,” the “tight” U.S. labor market has not experienced the demand destruction required to curb inflation.
As further evidence, ADP released its private payrolls report on Nov. 30, and the 127,000 net additions missed the consensus estimate of 200,000.
Please see below:
Source: Investing.com
However, the official report noted that wage inflation remains robust, and investors are in la-la land if they think output inflation will fall to 2% when wages are running north of 7%.
Please see below:
Source: ADP
To explain, ADP’s measures of wage inflation show that job-stayers enjoyed a 7.6% increase in their median annual pay in November, while job-changers recorded a 15.1% jump. Also, material wage inflation was present across several goods and service sectors, and these are not the kind of results that support a dovish pivot. If anything, the Fed will need to be more hawkish than the consensus expects, as higher wages should keep consumer spending elevated for the foreseeable future.
Overall, seasonality has the bulls in pole position, but the fundamentals have not changed: the Fed has an inflation problem, and no matter what Powell says, history shows that significant economic weakness is required to normalize the metric to 2%.
Hawkish Data Abound
While the crowd continues to buy hope and sell reality, the recent economic data has been profoundly hawkish. For example, while preliminary Q3 U.S. real GDP growth came in at 2.6%, the figure was revised upward to 2.9% on Nov. 30.
Moreover, with the GDP Price Index (inflation) also outperforming the consensus estimate, these metrics are nowhere near the levels that coincide with dovish pivots.
Please see below:
Source: Investing.com
The official release from the U.S. Bureau of Economic Analysis (BEA) read:
“The GDP estimate released today is based on more complete source data than were available for the ‘advance’ estimate issued last month. In the advance estimate, the increase in real GDP was 2.6 percent. The second estimate primarily reflected upward revisions to consumer spending and nonresidential fixed investment that were partly offset by a downward revision to private inventory investment.”
Thus, does “upward revisions to consumer spending and nonresidential fixed investment” sound like a backdrop where rate cuts are imminent?
To that point, the next time ZeroHedge cries wolf about a dovish pivot, please remember the site claimed that U.S. GDP growth was “rapidly collapsing” in January. Therefore, while narratives are entertaining, objectively analyzing the fundamentals is more useful in determining the path of monetary policy and the performance of the precious metals.
Please see below:
Source: ZeroHedge
Furthermore, while I warned for many months that inflation would persist for much longer than the consensus expected, the main difference between the crowd and myself is that the former assumed this bout of inflation was a supply-side spectacle. In contrast, I noted that demand was the primary driver, and that resilient consumer spending would intensify the pricing pressures. To explain, I wrote on Mar. 31:
There is a misnomer in the financial markets that inflation is a supply-side phenomenon. In a nutshell: COVID-19 restrictions, labor shortages, and manufacturing disruptions are the reasons for inflation’s reign. As such, when these issues are no longer present, inflation will normalize and the U.S. economy will enjoy a “soft landing.”
However, investors’ faith in the narrative will likely lead to plenty of pain over the medium term. For example, I’ve noted for some time that the U.S. economy remains in a healthy position; and with U.S. consumers flush with cash and a red hot labor market helping to bloat their wallets, their propensity to spend keeps economic data elevated. Likewise, while most investors assumed that consumer spending and inflation would fall off a cliff when enhanced unemployment benefits ended in September, the reality is that neither will die easy.
So, while the thesis unfolded exactly as expected, the crowd still underestimates consumers’ ability to keep inflation uplifted; and with the San Francisco Fed realizing its misstep, the data highlights why the FFR should have plenty of room to run.
Please see below:
To explain, the San Francisco Fed attempted to decompose the drivers of the core Personal Consumption Expenditures (PCE) Index’s year-over-year (YoY) increase. The blue, white and orange lines above represent supply, demand and ambiguous inflation.
If you analyze the right side of the chart, you can see that the white line (demand) has now surpassed the blue line (supply) as the primary driver of inflation. Thus, while supply chains have normalized and shipping rates have declined by upwards of ~80% YoY, output inflation has barely budged. As such, resilient demand has been the culprit, and the crowd doesn’t grasp how difficult this will make the Fed’s job in 2023.
Finally, Neil Dutta, Head of Economics at Renaissance Macro Research, highlighted the conundrum on Nov. 30. He wrote:
“At the moment, the Fed, like many companies, appears to be offside on economic growth. There are rumblings that the central bank is planning to pivot toward a slower pace of interest-rate hikes – a signal it believes the economy is weakening enough to bring down inflation. But, as I outlined above, the opposite is true: real growth is picking up. This will make the Fed's job even harder and force it to dispense with the ‘pivot’ before it really begins.”
He added:
“Even with improving supply chains, a mad scramble by companies to catch up with higher-than-expected consumer demand would keep inflation higher than the Fed's 2% goal. This, in turn, would force the central bank's hand. Instead of a softening economy and moderating prices allowing the Fed to pivot toward a more relaxed policy, a robust economy and stickier inflation would push it to continue hiking interest rates for longer than anticipated.”
As a result, while it may seem counterintuitive, resilient growth and consumer spending are bearish because they will force the FFR and real interest rates higher and hurt the S&P 500 and the PMs. So, while the crowd cheers on demand destruction (pivot hope), they should learn the hard way that it’s easier to believe it than achieve it.
Source: Business Insider
The Bottom Line
While gold, silver, mining stocks and the S&P 500 remain uplifted, they have bought into a narrative that’s failed them many times in 2022. In a nutshell: whenever an immaterial decline in some economic data point occurs, the dip buyers assume the Fed has accomplished its goal, which means a peak FFR, real yields and USD Index.
However, sustainably normalizing inflation is much more difficult, and a few months of progress is largely immaterial, especially when all of the optimism only loosens financial conditions and creates even more inflation. Therefore, the crowd misses the forest through the trees, and a significant reality check should confront the bulls in the months ahead.
In conclusion, the PMs were mixed on Nov. 30, as despite the afternoon rally, gold ended the day in the red. Moreover, the USD Index and the U.S. 10-Year real yield were under pressure as the pivot mania intensified. But, while the narrative suggests a new bull market has begun, the medium-term technicals and fundamentals signal profound trouble ahead.
Alex Demolitor
Precious Metals Strategist