Timeless Wisdom
This week was yet another painful week in the precious metals sector. Last week, HAI detailed how new Fed Chair Kevin Warsh and his unexpectedly hawkish post-FOMC presser rattled rates markets, put a charge into the dollar, and knocked precious metals lower. This week saw price action follow-through on those events. But last week HAI also detailed why, beyond the very short-term, this hawkish repricing now weighing on gold isn’t at all likely to last.
If Warsh and the Fed (in a sustained and meaningful attempt to bring inflation down to target) actually hike rates at the front end of the yield curve, where the Treasury Department just switched the vast majority of debt issuance over the last two and a half years, then the Fed will be opening the door to an interest expense-fueled debt spiral.
Now that the U.S. is several years into the process of shifting issuance to the front end of the curve, the rate of U.S. Treasuries rollover has begun rising exponentially (a record $8 trillion now due in the next 12 months alone). Higher short-term rates will now directly translate to an acceleration of higher average interest expense paid, and a higher fed funds rate meaningfully pulls forward a U.S. debt crisis via interest expenses.
That’s important to consider given that (over anything other than the very short-term, due to decades of market muscle memory) there is nothing more bullish for gold than rising real rates on a highly indebted, functionally insolvent, reserve currency-issuing sovereign caught in a debt spiral.
And again, all this hawkish repricing—which is a short-term headwind (but long-term tailwind) for gold—is based on a very questionable new hawkish Warsh doctrine implying interest rate hikes.
Critically, however, President Trump offered a reminder of his priorities this week. At the White House on Wednesday, Trump told reporters, “What you want to do is what’s good for everyone. Get the interest rates down! We have this numbskull that was the head of the Fed before, and he’s a stupid person, and we call him ‘too late’ because he was too late with the interest rates all the time. We need low interest rates. Low interest rates will solve everything!”
In HAI‘s view, the hawkish Warsh honeymoon is set to collide with devastating rate hike fiscal math as well as a president who has no patience for anything but cuts. Again, Trump reiterating that “we need low interest rates. Low interest rates will solve everything!” should tell us everything we need to know about the recent hawkish market repricing in response to the new Warsh doctrine. The hawkish repricing and the Warsh doctrine are both almost certainly fleeting.
Now, amid this week’s brutal price action there was at least one indication that perhaps the market is beginning to sort out the very real inconsistencies between rhetoric and reality. While both gold and silver made new correction lows this week, the gold and silver miners did not. This sort of positive performance divergence for the leveraged miners is often a bullish indicator that a sector recovery is close.
In short, when a rate hike campaign is a recipe for fiscal disaster and the President demands low interest rates because he believes low interest rates will solve everything (but inflation), it’s a good time to be skeptical of Warsh’s new perceived hawkish Fed trajectory.
When considering a trapped Fed facing both an inflation problem and a fiscal time bomb, along with the accelerating dedollarization of the international monetary order, HAI sees the correction in precious metals prices as a standout opportunity for medium and long-term asset allocation. Outside of the very short term, gold is going much higher whether the Fed hikes or cuts, in HAI‘s view.
This week, major French Bank Société Générale agreed, calling for a significant gold rally into year-end. The bank is also significantly increasing its allocation to gold in its multi-asset portfolio for the third quarter, from seven to 10 percent.
Famed economist Henry Hazlitt once said that “people have more faith in gold than they have in the promises or judgment of the government’s monetary managers.” HAI strongly suspects that if the new Warsh doctrine has temporarily inspired more confidence in the government’s monetary managers than gold, Hazlitt’s timeless wisdom reflecting fundamental reality is about to reassert itself all over again—and soon.
Weekly performance: The S&P 500 was off 1.95%. Gold was down 2.87%, silver was down 9.89%, platinum was down 5.37%, and palladium was off 5.97%. The HUI gold miners index was down 7.17%. The IFRA iShares US Infrastructure ETF was up 2.42%. Energy commodities were volatile and mixed on the week. WTI crude oil was off 8.27%, while natural gas was up 1.65%. The CRB Commodity Index was off 2.72%. Copper was off 3.67%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 3.96%. The Vanguard Utilities ETF was up 3.63%. The dollar index was up 0.60% to close the week at 101.37. The yield on the 10-yr U.S. Treasury was off 9 bps on the week, closing at 4.37%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
