Is the worst behind us, or does this correction have more room to run?
Despite the permalbulls oozing with overconfidence, we warned on May 5 that their discourteous behavior is often a precursor to a reversal. We wrote:
The crowd remains immensely confident, which is a positive sign, not a negative one. When the permabulls count their chickens before they hatch, we’re often near an inflection point. Consequently, we believe more pain will confront the PMs, as the risk-reward is heavily skewed to the downside.
Likewise, while the crowd thumbed their nose at the impact of higher long-term interest rates, the latter have weighed on the white metal’s performance.
Please see below:
To explain, the gray line above tracks the silver futures price, while the black line above tracks the iShares 20+ Year Treasury Bond (TLT) ETF. If you analyze the relationship, you can see that higher TLT prices (lower long-term interest rates) have been celebrated by silver.
Conversely, the sharp declines on the right side of the chart show how TLT is approaching its 2023 lows and the white metal has not been fond of the re-pricing. As a result, while many assumed a silver bull market was underway, long-term traction will be difficult until inflation, interest rates and the U.S. dollar stabilize.
Fed Musings
While Fed Chairman Jerome Powell said on May 19 that the FFR “may not need to rise as much” if the economy weakens, he warned that “the extent of that is highly uncertain.” As such, this is similar to what he said in 2021 and 2022. If inflation fades gracefully, the Fed can relax. If not, interest rates will need to rise further to cool the U.S. economy.
Please see below:
Also, Minneapolis Fed President Neel Kashkari said on May 23:
“Right now it’s a close call either way, versus raising another time in June or skipping. Some of my colleagues have talked about skipping. Important to me is not signaling that we’re done. If we did skip in June, that does not mean we’re done with our tightening cycle.”
He added:
“Do we then start raising again in July? Potentially, and so that’s the most important thing to me is that we’re not taking it off the table.”
So, while the crowd wants this rate-hike cycle to end – just like they did in 2022 – you can’t wish it into reality. On the contrary, there is a lot of pivot hope that’s not supported by the fundamental data.
Please see below:
Furthermore, St. Louis Fed President James Bullard said on May 22:
“I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner. I’m thinking two more moves this year – exactly where those would be this year I don’t know – but I’ve often advocated sooner rather than later.”
And Dallas Fed President Lorie Logan said on May 18:
“After raising the target range for the federal funds rate at each of the last 10 FOMC meetings, we have made some progress. The data in coming weeks could yet show that it is appropriate to skip a meeting. As of today, though, we aren’t there yet.”
Consequently, while some Fed officials like Jefferson and Bostic preach various degrees of patience, the reality is that GDP growth has outperformed expectations, which we warned would happen. And as long as this is the case, it spells trouble for the PMs.
Finally, while Bank of America’s Chief Investment Strategist Michael Hartnett had predicted a Q1 recession, he changed his tune on May 19, writing that if the Fed “mistakenly” pauses rate hikes, long-term interest rates will rise, “and if so, we most certainly ain’t seen the last Fed rate hike of the cycle.”
As such, the “pain trade” is higher interest rates, not lower.
Overall, many of our fundamental predictions have come to fruition. You can’t solve sticky inflation with long-term interest rates near 3% to 3.5%. Moreover, we warned throughout 2021 and 2022 that U.S. households were flush with cash and that cushion has continued to spur resilient demand. As a result, while the crowd is desperate for material disinflation, only mild progress has occured, and the base effects reducing the headline CPI are nearing an end.
Do you think the FFR will be closer to 6% or 3% at the end of 2023?
Alex Demolitor
Precious Metals Strategist