An Expected FED Cut and Gold’s Stealth Bull Market
The Federal Reserve delivered the expected cut in interest rates on Wednesday. The 1/2% drop was a bit more than most expected. After the announcement, markets were stable for the most part right after the announcement, and then rose sharply on Thursday but wobbled on Friday. Wall Street wanted the cuts, and they were delivered. As a cut of some magnitude was expected, it is likely it has already been factored into the price structure of the stock market.
Bonds have rallied as well, but not as much as expected. We still think the massive oversupply of bonds is hampering the “normal” reaction.
In the two weeks before this announcement, we had the weakest and strongest weeks of the year. Extreme volatility near old highs might be an apt description.
Speaking of old highs, the stock market appears to be poised to break out of what technical types call a triple top. If it succeeds and can hold that breakout for several days, stocks should continue to act well.
Above, we observe the S&P 500 rising comfortably above its 200-day moving average, congesting starting in July, forming a triple top, and breaking out on the news of the Fed rate cut.
Critics point out that the Fed has cut interest rates even though while there has been some improvement in some inflation metrics, we are still far from the 2% level they said was their objective. As our friend Wolf Richter of Wolf Street has pointed out:
“On a month-to-month basis in a most unwelcome development, “core services” re-accelerated for the second month in a row in August, to 5.0% annualized, which fueled the re-acceleration of the overall Consumer Price Index (CPI) and Core CPI. Core Services make up about 65% of the Consumer Price Index and include housing, healthcare, and insurance.”
In short, some underlying numbers suggest inflation is still showing a strong pulse, and the beast is not yet dead. This is particularly true in areas like services rather than goods. Also, recent inflation numbers have been helped by soft energy prices and deflationary forces coming from China. That may seem like a good thing, but if prices fall because of a drop in demand in China and elsewhere, they fall for the wrong reasons. Deflationary forces are more difficult for the Fed to battle than inflationary forces.
Cutting interest rates before inflation has been tamed suggests the FED is now more concerned about weakness in the labor market and the possibility of a recession. Investors might interpret this as the FED being weak on inflation because continued money printing is necessary to fund the federal government’s excessive spending.
Their timing could also be interpreted as political. With the election so close, why not delay for just 40-odd days until after the election to avoid the appearance of the Fed intervening in the election process? Or have they been compromised along with almost every other Federal agency? The Fed is supposed to be non-political, but the cut came just after a group of Democratic senators called on the Fed to lower rates.
It is arguable whether that was a factor, but the political optics don’t look very good, do they?
What seems surprising is that there is no apparent crisis at present. No major financial institutions are signaling instability, financial markets have been buoyant and not under particular stress, and there seems to be no crisis in the foreign exchange markets.
So, what is the reason for the cut at this awkward time? Inflation targets have not been met, the economy is still growing (albeit somewhat slower), current rates are not exceptionally high or punitive by past history, and underlying inflationary factors (huge budget deficits, money supply expansion) are still operable.
One interpretation is that the Fed sees more economic weakness coming and wants to be ahead of the trouble. Others say the weakness is already evident, they are behind the curve, and it is already too late to cut. Still others say it’s politics. Who knows for sure? What is important is that we have started an interest rate-cutting sequence.
Stocks are still enjoying a very good year, and recent corrections, whether due to employment numbers or Yen carry trade problems, have been shallow and short-lived. As we reported, there has been no discernable downturn in longer or intermediate price trends. If the economy can avoid recession, interest rate cuts should be bullish for equities.
One market that has gotten little attention has been the gold market. While the stock market has been powered by the excitement of everything related to AI, the gold price is actually beating the stock market so far this year.
The chart above is logarithmic, showing percentage changes (left-hand scale). Gold is the dotted line, and the S&P is the green line. Both are moving together and are up sharply for the year. Everyone seems to know about stock performance, but few know that gold is closely tracking this good action.
There is always an argument that gold reacts either to bad news or is a harbinger of bad news. An inert element should not outperform the world’s most prominent stock market, especially one whose performance has been dominated by companies at the forefront of the latest technological revolution. With the stock market near all-time highs and the public very bullish on the market, what is the “bad news” driving gold higher? It does not appear to be “inflation,” as the Fed and Wall Street think the worst has been seen.
Central banks have been big buyers of gold, actually record buyers. We have not seen this kind of buying since the early 1970s when post-war arrangements secured by the Bretton-Woods treaty collapsed, and the dollar was devalued. Why are central banks such big buyers and the public not? What do they see the public does not see?
We can measure public activity by the flows in and out of bullion Exchange Traded Funds and US Treasury Coin sales. For most of this year, there has been an outflow from ETFs, at least by Western retail investors. Only in the last four months has there been a modest uptick and positive inflows.
Last year, Treasury sales of bullion coins were down about 18%. In short, investors’ public behavior does not explain the advance of gold’s “stealth” bull market.
We know central banks have been big buyers, but governments may not be tipping their hands even then. For example, a recent story indicated Saudi Arabia had purchased an additional 160 metric tons of gold through a secret deal in Switzerland.
One of gold’s essential functions is to be a central bank reserve. Foreign banks hold gold because it is not a “promise” from some government, and investors should keep it for the same reason. The question is this: why are central banks now questioning the ability of governments to fulfill their promises?
It is either they are questioning their ability to pay, or they are worried they will be paid but in depreciated money.
We think their concerns and those of investors who have been accumulating gold were summarized in a front-page article in the Wall Street Journal on September 18th, “Harris and Trump Proposals Add to Soaring Federal Debt.”
That’s right. Nobody seems to care about the Federal Deficit, which is growing like crazy during a period of no crisis and economic growth. As we exceed $35 trillion in debt, one wonders what the deficit will do if we have a recession requiring more government “stimulus.”
While there is the implication that some budget trimming will occur if Trump wins (Elon Musk will look for efficiencies), the days when our budget crisis could be corrected by finding “waste, fraud, and abuse” in the budget have long since passed. Over 85% of the budget is now on automatic pilot, being driven by Medicare, Social Security, interest on the debt, and defense.
Besides, there is no guarantee that Trump will win. Harris would likely bring on an even greater wave of spending and deficits.
We are all for finding waste. Lord knows there has been incredible fraud and waste under Biden in COVID-19 aid and Green New Deal spending. But it is not enough to reverse the enormous structural deficits caused by our skewed demographics (faster growth in the elderly receiving payments than the young making payments) and the irreversible power of compound interest on the debt. Interest payments alone now exceed defense.
Given the threats abroad, it is unlikely defense can be cut. Entitlements can’t be cut because no politician has the will to do that, and compound interest is a power unto itself. In short, we are past easy or painless solutions.
We think more and more people and central banks are starting to conclude that nothing can be done politically until we are in crisis. During the crisis, a consensus might be formed to reduce the size of government and quit financing programs with printed or borrowed money. Or, we could go another way and see even worse deficits and inflation. The bad part is that we have to get through a crisis rather than avoid one.
This has long been a staple of “gold bug” thinking. However, the real fireworks will occur when that thinking begins to move from a small band of advocates to the public at large and big institutions like central banks.
As a measure of that, we would note that Goldman Sachs, the premier investment bank on Wall Street and money manager for the ultra-wealthy in America, now suggests that gold will go much higher than even at elevated levels. On September 12, they issued a report that, in part, said:
“The precious metal has increased more than 20% this year, peaking at a record of more than $2,500 per troy ounce. Goldman Sachs Research forecasts the price will reach $2,700 by early next year, buoyed by interest rate cuts by the Federal Reserve and gold purchases by emerging market central banks. The metal could get an additional boost if the US imposes new financial sanctions or if concerns mount about the US debt burden.
Gold is our strategists’ preferred near-term long (the commodity they most expect to go up in the short term), and it’s also their preferred hedge against geopolitical and financial risks.”
Goldman notes that as large as central bank purchases have been, unreported purchases may be much more significant.
Even with this recent assessment, Goldman appears somewhat cautious. Gold prices are already exceeding $2,600 per ounce and are moving higher because the Fed blinked. The Fed is more concerned about employment than inflation, suggesting they will tolerate more deterioration in the purchasing power of our money.
We have been bullish for some time. In the immediate future, there is a real risk we will elect an outright socialist as President in November.
Finally, since we are now seeing the first interest rate cuts in four years, and more are promised, how does gold typically act once the rate cut cycle starts?
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This chart takes us through “the modern era” of a hyperactive Fed, starting with the tech bubble implosion in 1999 and 2000. The red circles show the start of the interest rate-cutting cycle, and the gold line represents the gold price. Gold prices rose modestly after the 2000 rate cut sequence, rose sharply after the 2008 rate sequence, and sharply once again after the cycle started in 2020. In short, gold has tended to do very well once the cutting begins.
For those who do not own any gold, we suggest the first gold you buy be the real thing. Not a paper derivative or security like ETFs, but take possession directly of bullion coins themselves. ETFs, mining shares, and the like come only after you have established an insurance position and own the metal outright.
Our long-term sponsor, American Precious Metals, can assist. Call 602-840-5500 or 800-522-gold.
You can also talk to your financial advisor. However, our experience is that most are hostile to gold because it suggests a lack of faith in the currency, and all their products are denominated in that shrinking currency.
The serious problem is that, given our budgetary trajectory and political divisions, a lack of faith in our currency’s future purchasing power is wholly warranted.
Although we think the price will continue to trend higher, one does not buy gold for speculation. One buys gold for protection against government mismanagement of the money.
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Charts courtesy of Stockcharts.com produced by the author.
