Gold Is Fighting a Losing Battle

Despite investors’ attempts to create their own reality, gold’s fundamentals remain highly bearish.

With more hawkish data hitting the wire on Dec. 9, risk assets sold off into the close. Moreover, while mining stocks suffered from the bearish reversal, gold and silver continued their ascents. However, with investors highly uninformed about the resiliency of inflation, 2023 should be unkind to the PMs.

For example, the U.S. Bureau of Labor Statistics (BLS) released the Producer Price Index (PPI) on Dec. 9. For context, the metric measures the input inflation experienced by manufacturers and supply-chain companies; and with the PPI outperforming expecations, the data continues to highlgiht why the Fed’s inflation fight will be one of attrition.

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To explain, the red box above shows that the PPI increased by 7.4% year-over-year (YoY) and 0.3% month-over-month (MoM) in November, which came in above the consensus estimates of 7.2% YoY and 0.2% MoM. As a result, the slow death of inflation highlights why the U.S. federal funds rate (FFR) needs to go much higher to bring the metric back to its pre-pandemic trend.

Likewise, while we’ve warned on numerous occasions that ZeroHedge likes to create doubt with its recurring pivot proclamations, the site continues to buy hope and sell reality.

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Source: Twitter

But, while narratives create controversy and increase engagement, objectively analyzing the fundamentals is much more prudent from an investment perspective.

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To explain, the core PPI came in at 0.4% MoM in November, which was double the consensus estimate of 0.2% MoM; and while ZeroHedge continues to wish its pivot narrative into fruition, the data signals the exact opposite.

To that point, Costco released its first-quarter earnings on Dec. 8. For context, it’s the third largest retailer in the U.S. according to the National Retail Federation (NRF); and with its comparable sales remaining resilient, the results are far from recessionary, and nowhere near the levels that would support a dovish pivot.

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Source: Costco

To explain, Costco’s adjusted comparable sales in the U.S. and Canada came in at 6.5% and 8.3% YoY in Q1. For context, the adjusted metrics are more informative, because they exclude the impact of gasoline prices and currency fluctuations. As such, North American demand remains resilient, and the results are bullish for the FFR.

Furthermore, CFO Richard Galanti said during the Q1 conference call:

“Recall last quarter in fourth quarter, we estimated that YoY price inflation was about 8%. In the first quarter, we estimate the equivalent YoY inflation number in the range of 6% to 7%. Food and sundries is still up more than nonfoods, but overall, a little better level than a quarter ago for the company.”

Thus, while the company has seen "a little light at the end of the tunnel," Galanti noted that "it's still little" and that inflation remains highly problematic. Plus, when the Fed hikes the FFR 15 times in 2022 (25 basis point increments), and the tally should hit 17 on Dec. 14, reducing Costco's inflation from 8% to a "range of 6% to 7%." is nothing to write home about.

Consequently, realized inflation progress has been relatively minimal, and investors still underestimate the challenges that lie ahead. In a nutshell: demand destruction won't materialize on its own, and the Fed needs to push the FFR much higher to normalize inflation.

As further evidence, the Atlanta Fed updated its Wage Growth Tracker on Dec. 9; and with the consolidated metric coming in at 6.4% in November, it matched October's figure, and is only 0.3% below the all-time high of 6.7% set in June, July and August.

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More importantly, job switchers – those who leave one job for another – saw their wage growth decline from an all-time high of 8.5% in July to a recent low of 7.6% in October. But, the metric rose again in November and now stands at 8.1%, which means investors are in la-la land if they think output inflation will fall to 2% when overall wages are running north of 6%.

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For context, we warned on Dec. 5 that elevated compensation would prove problematic for the pivot bulls. We wrote:

With average hourly earnings (AHE) substantially outperforming expectations on Dec. 2, the fundamentals continue to unfold as expected.

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To explain, AHE increased by 0.8% MoM in November, which was more than double the consensus estimate of 0.3% MoM. Likewise, the 5.1% YoY increase also surpassed the 4.6% YoY estimate.

So, while more important data releases will commence on Dec. 12 , the recent results support a more hawkish Fed than the consensus expects, not less.

Finally, while the crowd bids up the gold price as if more QE is on the horizon, the liquidity drain (rate hikes + QT) should have plenty of room to run. Furthermore, even if the Fed pauses, history shows the development is bearish for the gold price.

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Source: Bank of America

To explain, Bank of America tallied the performance of various assets three and six months after the Fed’s final rate hike. If you analyze the top half of the table, you can see that the inflationary period from 1970 to 1988 (which is similar to the one we’re in now) resulted in gold declining by an average of 12.6% and 11.4% in the three and six months after the Fed’s final rate hike.

Thus, while we expect the FFR to go much higher before it’s all said and done, historical pauses amid high inflation have been unkind to the yellow metal; and while seasonality and sentiment keep the PMs uplifted in the short term, investors’ misunderstanding of the fundamentals should be their undoing in the months ahead.

Alex Demolitor
Precious Metals Strategist