Gold Rallies as Hawkish Fears Spread

If risk assets correct, will the gold price stay elevated?

While risk assets retreated on Jan. 30, gold and silver ended the day in the green. In contrast, mining stocks confronted further selling pressure, and the GDXJ ETF has recorded a three-day losing streak. 

However, a plethora of economic data could result in major swings this week, so it’s important to stay focused on the medium term. For example, not only does the FOMC take center stage on Feb. 1, but it’s a wild week for S&P 500 earnings.

Please see below:

To explain, the tall blue bar near the middle (1/30-2/3) shows that 35% of S&P 500 companies report earnings this week, which marks the busiest period on the schedule. Therefore, good and bad prints could influence after-hours sentiment, impact the futures market, and affect investors’ outlook for risk-on and risk-off assets. As a result, the noise should be amplified in the days ahead.

In contrast, the medium-term technicals and fundamentals remain on track, and the PMs should suffer mightily as the liquidity drain continues. 

We have warned for months that the crowd underestimates the peak U.S. federal funds rate (FFR) and ignores the historical lessons at their own peril. Moreover, with the U.S. housing market recovering from its recent lull, the results highlight why interest rates are too low to induce the demand destruction required to reduce inflation. 

Remember, the housing sector is the most sensitive to interest rates, and its resiliency is an ominous sign for the pivot bulls. Redfin Corporation – which operates a residential real estate brokerage in 95 markets in North America and abroad – wrote on Jan. 25:

“The housing market has begun to recover after hitting a low point in the second week of November….. The number of Redfin customers requesting first tours has improved 17 percentage points from the November trough” and “Redfin agents report that bidding wars are back in some markets, including Seattle, central Florida and Richmond, VA.”

In addition:

“Mortgage applications are up 28% from early November as the average 30-year-fixed mortgage rate (FRM) has declined to 6.15% from its November peak of 7.08% – the largest 10-week decline since 2009. That has sent the typical homebuyer’s mortgage payment down 10% (about $180) since fall.”

Please see below:

To explain, the blue (30Y FRM) and red (mortgage applications) lines above depict the relationship between interest rates and housing demand. As you can see, a less than 1% decline in the 30Y FRM increased buyers’ appetites and applications rose materially. Furthermore, if housing can’t suffer a slowdown of more than ~seven months, then interest rates are not high enough to stifle demand in less interest-rate-sensitive industries.

The report added:

“I’ve seen more homes go under contract this month than in the entire fourth quarter. Listings that were stagnant in November and December are suddenly getting one to two offers,” said San Jose, CA Redfin agent Angela Langone.

Consequently, the data supports our conclusion that inflation will not decline linearly. History shows that when inflation becomes unanchored, it ebbs and flows unless the FFR is high enough to collapse demand. That is not present right now. 

As further evidence, please see this Bloomberg headline from Jan. 29:

The article proclaims savvy retail investors are “flipping homes,” while Fintech and private equity firms incur losses. However, the housing market is often home to the least sophisticated retail investors with little understanding of inflation, interest rates and valuation; and history shows that retail investors suffer the brunt of the losses when the tide turns, and sadly, this time should be no different.

But, the important point is that if the dip buyers are still “flipping homes,” we’re far from peak interest rates.  

To that point, the Dallas Fed released its Texas Manufacturing Outlook Survey on Jan. 30. The headline index increased from -20 in December to -8.4 in January, and an excerpt read:

“Labor market measures pointed to stronger employment growth and longer workweeks. The employment index climbed four points to 17.6, a reading significantly above its series average of 7.9. Thirty-one percent of firms noted net hiring, while 13 percent noted net layoffs. The hours worked index held fairly steady at 3.8.”

Please see below:

To explain the red line above shows how the Dallas Fed’s employment index improved for the third time in four months and is at its highest level since July. Thus, we’re far from the kind of crash that would support a dovish pivot.

Also, while “Price pressures were generally steady and wage growth eased slightly in January,” this month’s “special questions” signal sticky wage inflation.

Please see below:

To explain, the red box above shows most firms still cite a lack of applicants as the primary deterrent to reaching adequate staffing levels. More importantly, 51% of firms noted that workers are asking for more pay than what is offered, and the January figure is near the ~50% threshold that’s been present since October 2021. Therefore, prospective employees are still driving a hard bargain, and if Americans were desperate for work, this wouldn’t be the case.   

Finally, while the momentum investors (CTAs) have helped push the PMs higher, other market participants have sold the rally. 

Please see below:

To explain, the gold line above tracks the gold price, while the purple, green and red bars above track the weekly ETF flows compiled by the World Gold Council. If you analyze the two major upswings in the middle and left side of the chart, you can see that a higher gold price culminated with ETF inflows. 

In contrast, the rally on the right side of the chart has been sold, and consolidated ETF flows have been negative for the last three weeks (updated on Jan. 27). As such, it’s another sign that momentum, and not fundamentals, is the driving force.

Overall, the data has not deviated from our expectations, and mining stocks are sending ominous signals. Remember, the implications of the FFR always exceeding the peak year-over-year (YoY) core CPI (north of 6%) is relevant because, throughout history, the Fed was forced to go further than it wanted. Yet, that’s often what it takes to win the inflation war. 

How do you view the recent weakness in mining stocks? Is it a bad sign for gold? What’s more important this week: corporate earnings or the Fed?

Alex Demolitor
Precious Metals Strategist