Economic Realities Punish Gold

After last week’s surge in Treasury yields, will the gold price stabilize or are lower lows ahead?

While the gold permabulls were sure the yellow metal was headed north of $2,500, we warned that artificially low interest rates would support economic growth and shift sentiment in a hawkish direction. We wrote on Apr. 6:

While the crowd assumes that demand destruction has arrived, a recession is imminent and QE is approaching (bullish for the PMs), the fundamentals contrast that narrative. In reality, inflation has not abated, and investors’ attempts to price in a recession intensifies its strength.

Remember, long-term interest rates have declined materially since the banking fears emerged. But, the development is stimulative because it lowers mortgage rates and makes financing more affordable….

When the crowd attempts to front-run a recession, it negates the recession due to the stimulative effect of lower long-term interest rates. That’s why sentiment surrounding [the PMs] has gone from euphoric to catastrophic several times over the last two years, and we believe another shift should occur over the next several months.

Thus, with the prediction proving prescient, economic outperformance has dominated the headlines in recent weeks.

Please see below:

Economic Realities Punish Gold - Image 1

To explain, the blue line above tracks Citigroup’s Economic Surprise Index. For context, a ‘surprise’ occurs when an economic data point outperforms economists’ consensus estimate. If you analyze the right side of the chart, you can see that the metric has soared to a new 2023 high as of Jul. 7. Consequently, the crowd missed the forest through the trees, and we warned that long-term interest rates needed to rise. 

Furthermore, with the economically-driven rate surge battering the iShares 20+ Year Treasury Bond ETF (TLT), the development has been bearish for assets like silver and has also helped boost the profits from our GDXJ ETF short position.

Please see below:

Economic Realities Punish Gold - Image 2

To explain, the black line above tracks the daily movement of the TLT ETF, while the gold line above tracks the daily movement of the GDXJ ETF. As you can see, the pair often move in the same direction, and the former’s drawdown has helped sink the latter. Moreover, with the TLT ETF closing at a new 2023 low on Jul. 7, there is more room for the GDXJ ETF to catch down. As a result, we expect more weakness before an opportunity to flip long materializes. 

To that point, the U.S. 10-Year real yield hit a new cycle high of 1.79% on Jul. 7. And while we warned that higher highs would occur, please remember that the metric was in the 2% to 3% range before the global financial crisis (GFC) and inflation was less problematic then. Therefore, financial conditions should continue to tighten in the months ahead.

Bye Bye Liquidity

The Fed’s balance sheet hit a new cycle low last week. The metric is now below the nadir set before the bank-run infusion, and the necessary drain is bearish for gold, silver and mining stocks. 

Please see below:

Economic Realities Punish Gold - Image 3

Furthermore, while the USD Index has been relatively muted compared to the uprisings in nominal and real yields, we believe the dollar basket is materially undervalued and should catch up over the medium term. 

Finally, inflation base effects end with this week’s headline Consumer Price Index (CPI) print, which means that resilient month-over-month (MoM) results will not be depressed by the high index levels seen during the outset of the Russia-Ukraine war. In addition, while recession narratives had depressed the crude oil price, it’s also found its footing in recent weeks, which is bullish for MoM inflation. 

Plus, with the Cleveland Fed expecting more resilient inflation prints to hit the wire, hawkish uncertainty should continue to upend the PMs.

Please see below:

Economic Realities Punish Gold - Image 4

To explain, the Cleveland Fed expects the headline and core CPIs to come near the 0.30% to 0.40% range in June and July. And since 0.30% and 0.40% MoM annualize to 3.66% and 4.91%, we’re a long way from the Fed’s 2% target.

Overall, while the S&P 500 remains in la-la land, bonds and the PMs have been battered in recent weeks. And with evaporating liquidity poised to remain a significant headwind, it’s likely only a matter of time before the index suffers a correction. And with rising volatility bullish for the USD Index and bearish for the PMs, the second half of 2023 should be much more unkind to the buy-and-hold investors. 

Are you surprised by the strength of Citigroup’s Economic Surprise Index?

Alex Demolitor

Precious Metals Strategist