As investors rotate into the laggards, gold may see some selling pressure.
While we warned for months that the economic data remained resilient and did not support a dovish pivot, the recession predictors continued to price in rate cuts (and still do); and despite their calls for a dovish 180 in August and October, the narrative still hasn’t borne any fundamental fruit. To explain, we wrote on Dec. 7:
The red line above tracks the U.S. 10-2 spread, which subtracts the U.S. 2-Year Treasury yield (2Y) from the U.S. 10-Year Treasury yield (10Y). In a nutshell: when the 2Y exceeds the 10Y, it's the bond market's way of warning about a forthcoming recession; and the development occurs because the 2Y is pricing in a higher FFR, while the 10Y is pricing in weaker economic growth.
Also, with yield curve inversion (10Y < 2Y) the talk of the town in recent days, the narrative proclaims that a recession is imminent. But, that's not what we see….
The 10-2 spread turned negative in December 1988, and the recession arrived in July 1990 (~20-month lag). The 10-2 spread also turned negative in February 2000 and the recession arrived in February 2001 (~12-month lag). In addition, the 10-2 spread turned negative in February 2006 and the recession arrived in December 2007 (~22-month lag)….
The moral of the story is that the 10-2 spread needs to turn positive before recession fears are valid
To that point, with Q4 real GDP outperforming expectations on Jan. 26, the fundamentals have not deviated from our expectations, and the outlook remains bullish for the U.S. federal funds rate (FFR), real yields and the USD Index.
Please see below:
Source: Investing.com
The official press release read:
“The increase in real GDP reflected increases in private inventory investment, consumer spending, federal government spending, state and local government spending, and nonresidential fixed investment that were partly offset by decreases in residential fixed investment and exports. Imports, which are a subtraction in the calculation of GDP, decreased.”
Now, while the perma-investors scream “lagged” whenever a strong GDP print materializes, please remember that they call the data lagged every quarter. Therefore, Q2 and Q3 were lagged, and now Q4 receives the same criticism.
As its stands, the important point is that demand remains resilient, the U.S. economy and the U.S. labor market have not collapsed, and the fundamentals support higher interest rates. So, while gold, silver and mining stocks have been uplifted by rate-cut optimism, the data continues to contrast that narrative.
In addition, earnings season has arrived, and the results from companies leveraged to the real economy are bullish for inflation and the FFR. For example, ADP – the largest human resources and payrolls firm in the U.S – released its second-quarter earnings on Jan. 25. CFO Don McGuire said during the Q2 conference call:
“With respect to the macro environment, the labor market continues to be strong. We're continuing to see our existing clients add employees.”
VP Danyal Hussain added:
“You could be in an environment where people have job postings and then they decide to pull them. How accurate that is, how great of a leading indicator that is, it's hard to say.
“At the same time, we have live data on pays per control as Don points out. We know with precision how many people are being added week-to-week. That's healthy. The job postings are healthy. Granted there are some signs of deceleration, layoffs and temp, but the bigger picture is still healthy.”
As a result, while we have warned for many months that a lack of demand destruction supports higher interest rates, the crowd still underestimates their prospective peak.
Likewise, Kimberly-Clark – one of the largest personal care products companies in the U.S. – released its fourth-quarter earnings on Jan. 25. CEO Mike Hsu said during the Q4 conference call:
“I would say, demand is holding up pretty well. I know that will be a topic people will want to double-click on. I would say, the elasticities are holding up better than we modeled originally.”
For context, ‘elasticities’ quantify the change in demand when prices increase or decrease; and while Kimberly-Clark racks up the price increases, demand has outperformed the company’s estimates.
More importantly, Hsu added:
“We have a significant portion of carryover pricing that was launched last year that still carries over into this year; and then, we've taken additional pricing actions since then; we've generally announced pricing actions across markets that are taking effect this quarter.”
So, while Kimberly-Clark’s average selling prices rose by 10% in Q4, more “pricing actions” will take effect in Q1.
Please see below:
To explain, the red box above shows that net pricing increased by 10% in Q4. Moreover, the blue box above shows that net pricing increased by 9% for the full year, which means that the Q4 price increases exceeded the average from Q1 to Q3. As such, the crowd’s inflation optimism contrasts the data from companies that sell items to everyday Americans.
On top of that, if you focus your attention on the columns to the left of the boxes, you can see that volumes declined across all categories in Q4 and for the full year. As it stands, Kimberly-Clark’s revenue growth was driven solely by price increases, and the dynamic is increasingly widespread.
Continuing the theme, Union Pacific – the second-largest railroad shipping company in the U.S. – released its fourth-quarter earnings on Jan. 24. CFO Jennifer Hamann said during the Q4 conference call:
“For 2023, we expect our all-in inflation to be around 4%, while cost per employee is expected to increase in the mid-single digits as elevated wage inflation is partially offset by productivity…. As we have demonstrated consistently, we expect to generate pricing dollars that exceed inflation dollars in 2023.”
Please see below:
To explain, Union Pacific’s average revenue per car (ARPC) rose by 8% in Q4, and since volume increased by 1%, the company raised its prices by ~7%. In addition, if “all-in inflation” hovers near 4% in 2023 and the group generates “pricing dollars that exceed inflation dollars,” its ARPC should rise by at least 5%. Consequently, these results do not support a 2% inflation rate anytime soon.
Overall, the economic and earnings data remain profoundly hawkish, and the fundamentals continue to align with our expectations; and while the PMs have rallied sharply due to the pivot sentiment, please remember that the crowd spends more time pumping narratives than doing their homework. That’s why their recession calls proved premature. However, higher interest rates should shift the mood music over the medium term, and the PMs should suffer mightily as the drama unfolds.
How can the Fed cut interest rates when inflation, earnings, spending and employment remain resilient? And how can the CPI hit 2% if large corporations are still raising their prices by much more? Is the crowd in for a wake-up call?
Alex Demolitor
Precious Metals Strategist