The Bulls Left Gold Behind

Despite the S&P 500’s recent surge, gold has materially underperformed. Is it an ominous sign, or can the yellow metal play catch-up?

While the crowd took solace in the FOMC’s June pause, its Summary of Economic Projections (SEP) was profoundly hawkish. For example, the committee upped its core inflation expectation and its expected interest rate path. Therefore, the medium-term outlook remains bullish for Fed policy

Please see below:

The Bulls Left Gold Behind  - Image 1

To explain, the 2023 median core Personal Consumption Expenditures (PCE) Index projection rose from 3.6% in March to 3.9% in June. More importantly, the 2023 median U.S. federal funds rate (FFR) projection rose from 5.1% to 5.6%. As such, FOMC officials expect stickier inflation and a higher FFR, which we’ve been warning about for months. We wrote on Apr. 14:

The PMs confront a precarious fundamental outlook, and mining stocks are particularly vulnerable. The rate-cut optimism contrasts the realities on the ground, and market participants are overconfident because the Fed has been wrong more than it’s been right. However, we believe the QE bulls will suffer disappointment in the months ahead.

To that point, while gold remains relatively upliftedthe GDXJ ETF has declined materially from its April highs. And with hawkish repricings continuing, more of the same should unfold over the medium term.

Please see below:

The Bulls Left Gold Behind  - Image 2

To explain, the blue line above tracks the December 2023 Fed Funds Futures contract. And since the price moves inversely to the yield, the sharp drop on the right side of the chart shows how the metric has nearly erased all of its bank-run rally.

Consequently, while we warned that the FFR would seek higher ground, the FOMC’s projections and the action in the futures market have validated our thesis. Furthermore, both should have more room to run.

Fed Chairman Jerome Powell said during his post-FOMC press conference on Jun. 14:

“It will be appropriate to cut rates at such time as inflation is coming down really significantly. And again, we’re talking about a couple of years out. As anyone can see, not a single person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate.”

He added:

“Nearly all committee participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year.”

So, with the fundamentals continuing to unfold as expected, the PMs remain vulnerable, and high-beta metals like silver should suffer mightily as the liquidity drain continues. For context, even the consensus has come around to our way of thinking.

Please see below:

The Bulls Left Gold Behind  - Image 3

To explain, Bank of America’s latest Global Fund Manager Survey showed that more than 60% of respondents assumed the Fed’s rate-hike cycle was over in May. Yet, those expectations have flipped, and the data was collected before the FOMC meeting. Despite that, we still believe the crowd underestimates the challenges that lie ahead, and recency bias has them falsely assuming that inflation will recede gracefully.  

Core Problems

While base effects and lower oil prices helped suppress the headline Consumer Price Index (CPI), the core CPI remains highly elevated. For example, it stands at 5.33% year-over-year (YoY), and the month-over-month (MoM) figure has been 0.30% or higher in each month since October 2021. Furthermore, it’s been 0.38% MoM or higher in each month for the last six months.  

In contrast, the Fed needs the metric to hit ~0.17% MoM to align with 2% annual inflation. In other words, we’re nowhere near substantial progress. And with the MoM strength poised to continue, the Cleveland Fed sees more hawkish data hitting the wire in July.

Please see below:

The Bulls Left Gold Behind  - Image 4

To explain, the bank’s researchers expect the headline and core CPIs to hit 0.42% and 0.43% MoM in June, which support annual inflation closer to 5%. And while volatile commodity prices make the headline CPI projection less reliable, the Cleveland Fed has been spot on with its core CPI estimates. 

As a result, we still believe that rate cuts are unrealistic, and the USD Index and real yields should benefit when reality returns. Remember, the Fed has pushed the FFR above the peak YoY core CPI in every cycle since the 1950s. And while the latter peaked north of 6.5%, the consensus assumes history is irrelevant. But, with the S&P 500 bubbling up again, it highlights why the FFR reached such heights to finally win the historical inflation wars.

Overall, our technical and fundamental thesis continues to unfold as expected. And while the USD Index remains undervalued, the GDXJ ETF is still profoundly weak, which has benefited our short position. Likewise, the downtrend should continue in the months ahead.

Do you think the FFR will be higher or lower than 5.6% by December 2023?


Alex Demolitor

Precious Metals Strategist