LAWRIE WILLIAMS: Gold and silver state of play
I had harboured suspicions that the US Federal Reserve might pull back from the brink and loosen its tightening policy in the light of worries about tanking the equity markets and contributing to the start of a US recession. But, in the event it did not do so at last week’s meeting and, after an initial dip, equities have, so far, mostly fallen at the prospect of asset purchases coming to an end by the next FOMC meeting in mid-March, and a programme of interest rate rises likely being implemented almost immediately thereafter. However the ups and downs in the equity indexes have so far probably been insufficient to make the Fed think again. Additionally Friday’s official nonfarm payrolls analysis came in far higher than expected which will have given the Fed even more confidence that its apparent tightening proposals are timely and correct.
On my initial thoughts, the Fed’s perceived intentions would normally be seen as positive for non-interest bearing assets like gold and silver. This may still be the case once the full impact of the Fed’s decision-making is analysed, but the initial reaction has been quite the reverse. How much some retrospective sharp rises in equity prices, since reversed again, are down to the Fed itself, or its allies, climbing in and helping support the policy decisions remains to be seen. It does appear to this observer, though, that the rises, when they occurred were an illogical path for markets, which should have become used to being buoyed up by Fed largesse and low interest rates, to follow.
An immediate consequence was an initial writing-down, quite sharply, of gold and silver prices, with the former falling back well below the $1,800 level on the downside and the latter dropping back sharply beneath the $23 mark. We said at the time that the drop in the gold price in particular was overdone as usual, and both major precious metals have recovered somewhat in the past week’s trade - gold rather more so than silver. The gold:silver ratio has climbed back to over 80 confirming that silver has indeed reacted to the latest Fed moves worse than gold. Whether this pattern will persist, given that some of the positive momentum seems to have completely disappeared for now from both gold and silver, remains to be seen, although the tentative recovery during the past week has to be encouraging for the gold adherent in particular.
On the other side of the coin, equities could yet weaken further as the prospect of a cessation of effective Fed money stimulus diminishes. Inflation may also continue to make its continued degenerative inroads into the purchasing power of the dollar which would be yet another blow to overall economic strength in the U.S. and globally.
The main reasoning behind the seemingly much more hawkish Fed policies has been its assessment that its maximum employment target has now been reached, which will have been enhanced, in the Fed’s eyes, by Friday’s jobs figures. That is despite the fact that the overall unemployment percentage is still slightly above the originally stated Fed target. The consequence of the Fed’s new position is that it has left it open to concentrate almost wholly on inflation suppression which may well involve a faster and more aggressive approach to interest rate rises. Thus some analysts are now predicting perhaps five or six rate hikes this year, rather than the three or four which had been the prior consensus. An alternative might be possibly fewer, but larger, rate hikes of say 50 basis points rather than the more normal pattern of 25 basis point increases.
A more aggressive interest rate hiking programme has been seen as negative for gold and silver, although it should be recognised that this has not necessarily been the case in previous periods of rising interest rates. Given the strength of the current inflationary trend, any Fed interest rate raising program would still almost certainly leave us with negative real interest rates which might make the non-interest generating precious metals even more attractive than before.
Meanwhile Q4 US GDP growth figures have also come in well in advance of expectations, which initially led to a further sharp boost to the US dollar index (USDX) to over 97, although it has fallen back again since. Kitco News, though, quotes Andrew Hunter, Capital Economics’ senior U.S economist as follows: "The acceleration in GDP growth to 6.9% annualized in the fourth quarter, from 2.3% in the third, mainly reflects a massive surge in inventories, which will be at least partly reversed in the first quarter of this year. The Omicron wave means the economy is starting 2022 on a much weaker footing and we expect growth to disappoint over the rest of this year too."
It appears from the daily statistical announcements that the recent Covid-19 virus wave in the U.S. has perhaps already passed its peak with the daily rate of new reported infections falling quite drastically during the past week. Nevertheless they still remain high, as they do in Europe, and the U.S. recorded mortality rate, which tends to lag the infection rate, has even exceeded 3,000 daily on occasion, with the total U.S. deaths total likely to hit the psychological 1 million level before the end of March. Which will likely impact the markets. They have already passed the 920,000 deaths mark, which is a worrying statistic by any count and are enormously higher than that reported in any other jurisdiction, although it is doubtful whether some nations have the necessary tools, or perhaps the desire, to report Covid-related deaths as rigorously as the U.S.
It should be borne in mind also that the Omicron strain may not be the last Covid-19 mutation to strike us. However, to set against this, it is apparent that vaccination programs and better virus understanding are perhaps making each successive incidence slightly less lethal.
The Fed will, presumably, be monitoring all the economic indicators closely and there has to remain the possibility (some would say the likelihood) that a further sharp fall is on the cards. If the more recent downturn continues, or even accelerates, the ‘Fed put’ could be resurrected, whereby the central bank pulls back on any further ultra-aggressive tightening or interest-rate rising programmes if it sees the economy beginning to dive towards serious recession. We would put a 50:50 chance of this occurring within the next few months, although the Fed now seems to be less worried about precipitating a recession than it had been previously,
The Fed may thus be taking a leaf out of the Volcker book of 1979/80 when interest rates were indeed raised very sharply in the light of an extremely high inflation rate (which was well in excess of that so far seen this time around). This did tip the US economy into recession, but in retrospect has been seen as a necessary solution to the then high inflation predicament. What may hold the Fed back from so doing this time around, though, is that higher interest rates would make the cost of servicing the massive debt the US has built up = now estimated at over $30 trillion, in part to mitigate the adverse economic effects of the virus pandemic - untenable in terms of the necessary cash outflows of so doing.
We are thus in a bit of a quandary in terms of any realistic path out of the current economic malaise. Watch the Fed for any rapid policy changes and their attributed nuances. They will be key to any investment decisions on either equities or precious metals you may need to implement in the near future. We do think that precious metals may come out of the current economic situation stronger than equities, but nothing is certain in this day and age when social media seems to be driving markets more effectively than traditional investment fundamentals.