Should Be Fun
This week was a big week. It delivered the first step toward a hoped-for peace deal with Iran, along with the first post-FOMC press conference from new Fed Chair Kevin Warsh. By the end of this holiday-shortened trading week, however, precious metals were back in the crosshairs of sellers looking to bail on monetary metals for fear of the new monetary sheriff in town and his super-hawk performance on Wednesday.
After acknowledging that inflation has been running well above the Fed’s long-stated inflation goal of two percent for more than five years, and that “persistently high prices are a burden for the American people,” Warsh boldly defined his mission statement. Post-FOMC Warsh said, “recent past need not be prologue. I am pleased to report that members of the FOMC are unambiguous and unanimous: This Committee will deliver price stability.”
So, there you have it. Powell and his Fed underlings didn’t get it, Warsh and the same underlings do. Game, set, match. Warsh defeats inflation before he’s even finished decorating his new office. Awesome!
Now, in the wake of Warsh’s “victory,” let’s step back, re-assess the Fed’s circumstances, and try to separate bold narrative from stark reality.
U.S. entitlement spending, interest expense, and defense spending (not even including newly planned major increases in defense spending) combined soak up all U.S. government revenue. That leaves income security, veterans benefits, education, transportation, international affairs, and justice expenses all to be perpetually funded with borrowed money.
In other words, the fiscal position of the United States requires inflation.
Out of the big three line items (entitlement spending, interest expense, and defense spending), interest expense is the only politically viable one to cut.
If Warsh hikes rates (increases interest expenses) to fight inflation (inflation that helps reduce the value of the debt over time), then the U.S. dollar rises, 10-year U.S. Treasury yields rise (as do other Western 10-year yields), U.S. tax receipts (income and cap gains) fall with the financialized economy and equities, and foreigners sell U.S. Treasuries (to service $13-14T in U.S. dollar-denominated debt and defend their currencies). This would destroy the already highly problematic U.S. fiscal position and touch off a U.S. and Western sovereign debt spiral until more inflationary U.S. dollar liquidity is printed and injected into the system.
In HAI‘s view, this is the reality. Since the Fed hiked rates to quell inflation in 2022 and 2023, long-term sovereign bond yields have broken out dramatically to the upside. Given the acute Western debt and deficit problems, Western sovereigns absolutely cannot afford these high and rising bond yields on their now massive debt loads.
Since 2023, the U.S. Treasury department responded to those surging long-term rates by dramatically shifting debt issuance to the front end of the yield curve. In HAI‘s view, it seems clear that this dramatic shift of issuance was part of a multifaceted plan to manage the crushing impact of higher rates on U.S. interest expense. Step one of that plan was to shift issuance to the short end of the curve where the Fed actually controls interest rates. Step two, it would seem, was for the Fed to aggressively cut federal funds and tank rates at the short end of the curve. This was another in a long line of efforts not to solve the fiscal problem but rather kick the can down the road.
However, stubborn inflation, a stubborn Jay Powell, and Fed institutional credibility concerns all conspired (much to President Trump’s very public dismay) to derail that plan to manage interest expense. By extension, they also derailed the plan to manage the debt and deficit crisis.
Now, if you’re going to shift U.S. Treasury issuance to the front end with the goal of then cutting rates and lowering financing costs, then the one thing you absolutely cannot have is the Fed actually hiking rates at the front end where the Treasury just switched the vast majority of debt issuance. That would be a disaster, and disaster is exactly where we are now. In other words, the entire plan to shift issuance to the front end and then cut rates may be about to backfire in dramatic fashion if Warsh hikes rates.
So, while Warsh sparked fear in the hearts of many gold holders this week, HAI saw gold channeling Harry Callahan. Watching Warsh insinuate rate hikes, gold quietly said: “Go ahead, make my day.”
Once this trap springs on Warsh and the Fed, gold is going much higher whether the Fed hikes or cuts. If Warsh neglects to hike rates and effectively abandons the inflation mandate in favor of a shadow third mandate to cap yields and protect the U.S. fiscal position, that’s extremely bullish for gold. Alternatively, if Warsh hikes, there is nothing more bullish for gold (outside of an initial sell-off due to decades of market muscle memory) than rising real rates on a highly indebted, functionally insolvent, reserve currency-issuing sovereign caught in a debt spiral.
Gold appears highly likely to win because we appear highly likely to have one of those two outcomes.
Additionally, HAI found the following exchange at the post-FOMC Q&A between Howard Schneider and Chair Warsh potentially pregnant with insight.
Schneider asked, “And just specifically on the inflation framework, you talk about first principles. Does this include a review of the two percent target itself? You’ve mentioned that things to the right of the decimal point don’t matter. Should this be starting from a premise that two percent as a point estimate is too strict?”
Warsh responded by saying, “On the two percent inflation objective, that is the Federal Reserve’s long-held objective of two percent. You’ve heard me say before I tend to focus on the left of the decimal point. Well, the two is the left of the decimal point. For now, zero is to the right. I see no reason until we have reestablished our commitment and ability to deliver on the two percent inflation objective to revisit that.”
It seems to HAI that perhaps embedded in Warsh’s answer is an indication that the Fed will hike rates and try to tag the two percent bogey first (for credibility’s sake), and then revisit the issue of whether two percent is “too strict.” When Warsh said “I tend to focus on the left of the decimal point” he’s already warming us up to the idea that above two percent is actually fine with him.
Time will tell, but HAI remains convinced that what is by far least likely to happen is that the inflation problem and fiscal problem both resolve quietly. That’s because you can only attack one by inflaming the other—full stop.
Meanwhile, the other big news of the week was a signed MoU with Iran on an initial peace deal. HAI has been speculating from the start of the Iran conflict (given that China and Russia are Iran’s backers) that this might be a part of the negotiation process for what Scott Bessent described two years ago as a “grand global economic reordering.”
To review: on June 6, 2024 at the Manhattan Institute, Bessent said, “We’re also at a unique moment geopolitically, and I could see in the next few years that we are going to have to have some kind of a grand global economic reordering, something on the equivalent of a new Bretton Woods… There’s a very good chance that we are going to have to have that over the next four years, and I’d like to be a part of it.”
Only time will tell, of course, but this week Bessent tweeted on X, “President Trump continues to make the world safer, today reaching a historic peace deal with Iran. His leadership, along with his direct engagement with allies and adversaries alike, will be recorded in history books for centuries to come.”
Now, Bessent knows history (he used to teach economic history) and is certainly among the most financially savvy Treasury Secretaries we’ve ever had—if he doesn’t top them all. He also knew we needed a “grand global economic reordering.” This week, he called the Iran deal “historic,” and said that Trump’s deal “will be recorded in history books for centuries to come.”
Again, only time will tell, but unless this is just typical political posturing over a deal that frankly doesn’t look so good for the U.S. on the surface (certainly possible), Bessent’s comments might indicate that, below the surface, the Iran deal is part of that “grand global economic reordering” and a major global currency system restructuring. Again, only time will tell.
But if that were the case, headlines like those in this week’s Wall Street Journal (“China Moves to Boost the Use of Yuan Globally”) and Financial Times (“China tees up digital payments system to compete with dollar”) are exactly what you would expect to see.
You would also expect to see confirmation of the underlying drivers of a gold bull market that has foreshadowed a needed global monetary regime shift. This week, we got that as well with a Bloomberg article titled, “More Central Banks Say They’re Planning to Buy Gold This Year.” According to the article, “More central banks than ever expect to increase their gold reserves, a sign one of the key forces behind bullion’s record-breaking rally remains intact despite this year’s pullback.”
And if a monetary regime shift that brings gold back into the global system was in fact underway, you would also expect a global gold repatriation theme to set in. And we can check that box, too, with this week’s Financial Times article titled, “Central banks repatriate gold as global insecurity rises.” As the FT put it, “Global central banks are removing gold from vaults in London and New York as they become more skittish about storing bullion outside their own borders, according to a new survey.”
HAI very much understands that holding precious metals has been extremely painful since late January, but this author cut his teeth in this industry in the 2008 great financial crisis. One of the GFC’s lessons was that volatility and draw-downs are an unavoidable part of market participation—even when you are parked in the right place. In HAI‘s view, there are major trends that have occasional counter-trend moves embedded within them.
Gold is in a major trend toward much higher prices. At present, we are in a lesser countertrend move lower. Fundamentally, the major up-trend is supported by a weaponized U.S. dollar system and the simple fact that, given inflation and the U.S. fiscal situation, the yields being paid on U.S. bonds don’t offset the decline in the bond’s price relative to gold. More importantly, gold’s major bull market is underpinned by the growing realization that, with U.S. debt growing by 8% CAGR since 2008 and US debt/GDP at 123% and rising, the yield the U.S. would need to pay on its debt to offset the decline in its bonds’ prices relative to gold would put the U.S. and world into a debt spiral.
The weaponized dollar and utterly brutal fiscal math are the simple yet extremely powerful fundamental major secular drivers higher for the gold price. The lesser counter-trend move is driven by the narrative that Kevin Warsh and his committee “will deliver price stability.” But, as HAI stated earlier, if Warsh actually delivers price stability, he will also drive a Western sovereign debt spiral to do it.
HAI holds high conviction that the major trend will reassert itself—and likely sooner rather than later.
Friday on Twitter/X, reaching his social media breaking point after recent criticism for his bullish view on precious metals, famed technical analyst Michael Oliver offered his last tweet of the year. He said, “Besides sharing some interviews, we’ll take a break from Twitter until Christmas. Gold and silver will end this year at new ATH (all-time highs) and continue higher… The Federal Reserve, the progenitors of inflation, the prison wardens…will never and have never ‘solved’ inflation. But go ahead, believe Kevin, panic-sell your gold! We’ll be back on Twitter at the end of the year. Should be fun.”
HAI agrees with Mr. Oliver (both fundamentally and technically), and similarly expects gold and silver to produce new all-time highs by year-end. And yes, for precious metals holders, it should be fun!
Weekly performance: The S&P 500 was up 0.93%. Gold was down 0.28%, silver was down 3.11%, platinum was down 0.29%, and palladium was off 0.19%. The HUI gold miners index was up 3.07%. The IFRA iShares US Infrastructure ETF was up 0.20%. Energy commodities were volatile and mixed on the week. WTI crude oil was off 9.75%, while natural gas was up 3.62%. The CRB Commodity Index was off 1.84%. Copper was up 0.87%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 2.88%. The Vanguard Utilities ETF was up 0.55. The dollar index was up 0.96% to close the week at 100.76. The yield on the 10-yr U.S. Treasury was off 3 bps on the week, closing at 4.46%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
