However, with inflation soaring and the Fed peddling, bond prices have fallen, yields have risen, and risk/risk aversion sentiment has done little to reaffirm the historical relationship. However, keep in mind, the bond market is pricing in the implications of the Fed’s war on inflation, while the general stock market and the PM are not. Thus, the safe-haven supply of US Treasuries has evaporated and, in this upside-down world, equities and commodities experience much less volatility.
So, remember that short-term movements in financial markets are not based on fundamentals. Instead, algorithms analyze sentiment indicators, and as long as momentum is bullish, why worry about medium-term fundamentals?
Think of it like this: we could present a quantitative trader with data that supports caution over the medium term. However, he would respond with… who cares? In reality, aggressive investors are so focused on the short term that their strategy is to ride the wave higher and run away at the first sign of trouble. As a result, with the PM showing less volatility, aggressive investors did not see the red flags that would prompt them to exit their positions.
Additionally, a follower asked me if “gold is now the only risky asset left standing” and if “that would explain why gold has been so resilient.” To answer, the conclusion is correct.
As investors hide in gold despite falling domestic fundamentals, the Russia-Ukraine crisis has provided cover for overzealous investors. However, while gold permabulls use the high price to justify their narrative, the reality is that “those who cannot remember the past are doomed to repeat it.”
For context, we expect PM to spike in the longer term. However, with the Fed peddling and its rate hike cycle just beginning, we should see some steep declines before their secular bull markets continue.
At this point, I’ve written extensively about US real yields over the past few months. With the metric bullish for the USD index and bearish for the PM, I warned on Feb. 7 that the former’s short-term pullback contrasted with fundamental reality. I wrote:
To explain, the green line above tracks the USD index since January 2020, while the red line above tracks the US 10-year real yield. While the latter did not bottom in January 2021 like the USD index and the FCI (although it is close), all three surged in late 2021 and reached new highs in 2022. Additionally, nominal and real 10-year US Treasury yields hit new highs in 2022 on February 4.
Additionally, with the Fed likely to raise interest rates at its March monetary policy meeting, an awareness supports a higher US 10-year real yield and higher FCI. As a result, the fundamentals underlying the USD index remain strong, and short-term sentiment is likely responsible for the recent weakness.
So, while algorithms have won the battle in the short term, fundamentals have won the war in the medium term. Moreover, with the surge in the US 10-year real yield in recent weeks, the USD index has reacted as expected.
Please see below:
However, the continued optimism in gold prices is similar to the decline in the USD index in February. For example, the algorithms pushed the USD index lower when the momentum turned. However, reality resurfaced over time. Likewise, the algorithms are pushing the PM higher now, but the reality should also reappear over the next few months.
To explain, I wrote on January 12:
PMs are less volatile than speculative assets. However, it is important to remember that gold, silver and mining stocks peaked amid the liquidity-fueled surge in the summer of 2020. Likewise, their rises coincided with real interest rates that were at historically low levels at the time.
Conversely, with the Fed’s cash drain already underway and real interest rates poised to rise in the coming months, MPs are likely to suffer from likely price revisions. For example, when the US 10-year real yield was 0% or higher from June 2013 to October 2018, gold was stuck below $1,400 during that time and actually fell below $1,100. As a result, if the Fed pushes its hawkish tokens into the middle, don’t be surprised if the PMs pull back in 2022.
Please see below:
At this point, the US 10-year real yield surged in 2022, and hawkish remarks from the Fed raised the metric to -0.16% on April 7.
Please see below:
For your reference, the gold line above tracks the gold futures price, while the red line above tracks the US 10-Year Inverted Real Yield. For context, inverted means the latter’s scale is reversed and a rising red line represents a falling US 10-year real yield, while a falling red line represents a rising US 10-year real yield .
If you analyze the left side of the chart, you can see that when the US 10-year real yield jumped for the taper tantrum of 2013 (represented by the red line moving sharply downward), gold has plunged over $500 in less than six months.
Additionally, if you focus your attention on the right side of the chart, you can see that the US 10-year real yield is trending toward neutral, and the Fed needs to push the metric above 0% to rein in inflation.
As a result, the data couldn’t be clearer, and the fundamental outlook for the USD index and the US 10-year real yield is more bullish now than at the end of 2021. However, because algorithms rule the roost in the short term, when reality resurfaces is unclear.
Despite, if we take the Russian-Ukrainian conflict out of the equation, this is one of the worst medium-term fundamental setups for gold in a long time. Therefore, while the permabulls will shout that “this time is different”, history shows that the yellow metal can only ignore rising real yields for so long.
Additionally, I wrote on April 7 that FOMC minutes show that officials plan to raise interest rates several times over the next few months. Moreover, their use of terms such as “faster”, “faster” and “rapidly” is not bullish for the PM or the S&P 500. In addition, the crew also committed to start reducing the balance sheet of about $95 billion a month” at an upcoming meeting. Similarly, the Fed minutes also said:
“Many participants noted that one or more 50 basis point increases in the target range may be appropriate in future meetings, particularly if inflationary pressures remain high or intensify. A number of participants noted that previous communications from the Committee had already contributed to a tightening of financial conditions, as evidenced by the notable rise in longer-term interest rates in recent months.
As a result, the medium-term outlook remains unchanged: the Fed could double its rate hikes in “one or more” meetings, and the future path depends heavily on inflation. However, with the latter still raging, the chances of a dovish pivot are slim to none.
As proof, the Institute for Supply Management (ISM) published its services PMI in the United States on April 5. Moreover, the overall index fell from 56.5 in February to 58.3 in March. The report revealed:
“Prices paid by service organizations for materials and services rose in March for the 58th consecutive month, with the index registering 83.8%, 0.7 percentage points higher than February’s figure of 83. .1%. This is its second highest reading on recordbehind the seasonally adjusted figure of 83.9% recorded in December 2021.”
“Employment activity in the service sector increased in March after contracting in February. ISM‘s The services employment index recorded 54% in March, up 5.5 percentage points from 48.5% in February. Comments from respondents include: “Labour shortages appear to be improving as omicron has decreased” and “Hiring is returning to normal levels”.
As such, all of this is bullish for Fed policy.
Similarly, S&P Global also released its US Services PMI on April 5. Here, the overall index fell from 56.5 in February to 58.0 in March. The report revealed:
“On the pricing front, companies saw a substantial increase in production charges during the month of March. The increase in selling prices was the strongest on record (since October 2009), as service providers would have passed on the higher costs to customers, where possible. »
For more context:
Even more optimistic for Fed policy:
The bottom line? While momentum remains gold and silver’s best friend, their domestic fundamental outlook has deteriorated sharply in 2022. The USD index and US real yields have risen dramatically, and the Fed has made switch the hawkish dial from 60 to 100. However, the PMs largely ignored all of these troubling developments.
Despite this, history shows that techniques and fundamentals prevail in the medium term. Additionally, while sentiment remains elevated for now, the pendulum may swing without warning. When that happens, the PM will face one of the worst domestic fundamental environments since late 2018.
In conclusion, the PMs rallied on April 7, because momentum does not die easily. However, with the medium-term bearish thesis becoming clearer day by day, investors are fighting a battle they have not won in 10 years. As a result, although the timing remains uncertain, PM is likely to experience deep declines once sentiment changes.
(By Przemyslaw Radomski)