Is Gold Running Toward a Cliff?

As the gold price rises, its fundamental foundation continues to weaken. 

With gold, silver and mining stocks continuing to climb on Jan. 4, the metals have become the momentum kings of the financial markets. However, while their prices head in one direction, their fundamentals have diverged. As a result, when market participants come around to the hawkish realities that are bearish for many risk assets, the PMs’ drawdowns could be fast and furious.

To explain, the narrative proclaims that the Fed will pivot in 2023, and the front running has begun for the PMs. But, the fundamentals do not support this thesis, and the employment data signals a much more hawkish outlook,

The U.S. Bureau of Labor Statistics (BLS) released its JOLTS job openings report on Jan. 4; and with hiring intentions outperforming expectations, the medium-term outlook for wage inflation remains highly bullish.

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To that point, with nearly 4.5 million more job openings than Americans unemployed, the imbalances built up post-pandemic have decelerated at a snail’s pace. Therefore, the U.S. federal funds rate (FFR) needs to continue its ascent to normalize supply and demand in the U.S. labor market.

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To explain, the red line above tracks the number of unemployed Americans from the number of JOLTS job openings. If you analyze the right side of the chart, you can see that labor demand remains well above supply, and investors underestimate the liquidity drain required to restore the historical symmetry.

Likewise, the Institute for Supply Management (ISM) released its manufacturing PMI on Jan. 4; and while the headline index declined from 49 in November to 48.4 in December, an excerpt read:

“ISM's Employment Index registered 51.4 percent in December, 3 percentage points higher than the November reading of 48.4 percent…. An Employment Index above 50.5 percent, over time, is generally consistent with an increase in the BLS data on manufacturing employment.”

In addition, S&P Global released its U.S. manufacturing PMI on Jan. 3. The headline index declined from 47.7 in November to 46.2 in December. However, the report stated:

“Firms recorded only a slight increase in employment. The rate of job creation was the second-slowest in the current 29-month sequence of growth, as some firms filled long-held vacancies for skilled workers.”

So, while varying degrees of strength are present, the important point is that U.S. firms are still increasing their headcount, and labor demand remains robust. As such, the results are bullish for wage inflation, output inflation and the FFR. In turn, the backdrop is also bullish for real yields and the USD Index, and it’s likely only a matter of time before the PMs wake up to these fundamental realities.

As further evidence, the number of Americans quitting their jobs increased in November, which highlights their confidence in finding other opportunities. Remember, individuals only voluntarily leave positions when better ones arise or when they’re in secure financial positions. Consequently, the data highlights why the liquidity drain needs to continue to create the necessary demand destruction to reduce inflation. 

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Speaking of which, Nick Bunker, Economic Research Director for North America at the Indeed Hiring Lab, wrote on Jan. 4:

“The U.S. labor market remains on fire. The flames may have receded a bit from the highs of the initial reopening of the economy, but demand for workers remains robust and workers are seizing new opportunities. By any measure, the new data from this report shows a tight, hot labor market. A labor market this strong means an imminent recession is highly improbable.”

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Source: Indeed

On top of that, we warned on Dec. 7 that investors’ recession fears were premature and that the FFR’s best days still lie ahead. We wrote:

With the recession narrative contrasting the data, gold’s medium-term drawdown should be driven by a higher FFR, not an unprovoked collapse of the U.S. economy. 

To explain, a recession is bullish for the USD Index and bearish for the FFR, while a resilient U.S. economy is bullish for both. Therefore, while we’ve warned repeatedly that every inflation fight since 1954 has ended with a recession, and we expect one to materialize in late 2023, timing matters.

Furthermore, with the current and historical data contrasting the collapse calls, financial conditions need to tighten dramatically to curb inflation and create the necessary demand destruction to induce a recession. So, the FFR should seek higher ground, and the liquidity drain should continue to haunt the PMs.

Consequently, while the PMs rally as they assume the opposite, the fundamentals continue to unfold as expected: demand is outperforming expectations, and the crowd underestimates the ramifications for rate hikes and QT.

Also revealing, imbalances during the pandemic created a boom-and-bust cycle for technology employment; and with major layoffs announced in recent months, investors assumed that the isolated weakness was prevalent across all industries.

Yet, we warned this thesis contrasted reality, and the Wall Street Journal (WSJ) reported on Dec. 27:

“Most laid off tech workers are finding jobs shortly after beginning their search, a new survey shows, as employers continue to scoop up workers in a tight labor market.

“About 79% of workers recently hired after a tech-company layoff or termination landed their new job within three months of starting their search, according to a ZipRecruiter survey of new hires. That was just below the 83% share of all laid-off workers who were re-employed in the same time frame.”

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Thus, the key point is that the U.S. labor market remains resilient, and even the weakness in the technology sector is less ominous than feared. As a result, interest rates are too low to win this inflation battle, and recency bias has the bulls following the post-GFC script. Remember, it’s easy for inflation to decelerate from 8%. But, with wage inflation running at 5%+, the Fed needs to materially cool the labor market to achieve further progress, and the ramifications are far from priced in.

Overall, while the PMs have built their castles on faulty foundations, the bulls are happy to let the price action guide their positioning. However, with household checkable deposits at a record high and wage inflation not far behind, our message throughout 2021 and 2022 remains as relevant as ever: consumers are flush with cash, demand won’t plunge on its own, and the crowd underestimates the potential for higher-for-longer interest rates.

Alex Demolitor
Precious Metals Strategist