Top in Interest Rates or Top in Gold?

So, the Fed did as expected, raising the rates by 0.25%. But that didn’t really matter.

What mattered was what was said later.

And how it was then interpreted.

Powell’s 0.25% hike was expected, so when it became a reality, markets didn’t really react. But what changed was the narrative regarding the future price moves. Powell said that they will make further decisions based on the data that they get. So, Powell is no longer saying about further increases but about being data-dependent. The latter is irrelevant because the Fed is always data-dependent, at least in theory (theory says that there are no political influences on the Fed, too…). The former, however, means that the pause is on the table.

That’s what was said.

What does it mean? It means that if the inflation isn’t lower, they will have to raise rates again. Why? Because inflation is political – simple as that. That’s the thing that voters are most concerned with, and that’s a fact.

If the inflation does move lower, they will probably not be raising rates again.

Also, Powell added that he doesn’t plan to cut rates anytime soon.

"Inflation [is] going to come down not so quickly," he said, yesterday. "It will take some time. And in that world, if that forecast is broadly right, it would not be appropriate to cut rates."

So, to summarize what’s likely to happen: the rates are either moving higher if the inflation doesn’t decline or the rates are staying where they are if inflation declines visibly.

In both cases, real interest rates (nominal rates minus expected inflation) are going to increase. So, both outcomes presented by Powell are bearish for gold and the rest of the precious metals sector.

Now, since people, in general, prefer to hear what they want to hear rather than hearing what is indeed being said, here’s what the market is currently expecting (charts are from the CME FedWatch tool):

Top in Interest Rates or Top in Gold? - Image 1Top in Interest Rates or Top in Gold? - Image 2Top in Interest Rates or Top in Gold? - Image 3

People expect that it’s practically certain that the rates will stay as they are on the next Fed meeting and that they will then start to decline. In other words, the market participants think that the rates are going to decline within the next couple of months, but not necessarily in June.

Please note the contrast between the current expectations and what I wrote above as the scenarios that Powell pretty much revealed.

For a long time, we’ve been emphasizing that inflation is much stickier than many expect, so it’s much more likely that what Powell is saying about the rates and the outlook for them is much more realistic than what the market largely expects right now.

Why would the market be wrong at this time? Because of the stage of the bull/bear cycle, it’s in.

Top in Interest Rates or Top in Gold? - Image 4

We’re probably in the “return to “normal”” part right now, and the most recent upswing was a bull trap. The “New Paradigm” top was likely the moment when many thought that interest rates could be kept very low for decades and during the crypto peak.

Even the name makes perfect sense in light of yesterday’s news and the current expectations. The “return to normal” in this case, means a return to “normally” low interest rates.

So, what does that all imply? That the market is likely to be surprised – negatively so. It’s obvious also from the technical point of view, and I’ve been writing about the bearish stock price forecast for quite a long time now.

Top in Interest Rates or Top in Gold? - Image 5

Stocks just failed to move to new 2023 highs. They got close but declined shortly thereafter. It looks like we’re going to get the right shoulder of the head-and-shoulder top formation completed in the following weeks.

Commodities like crude oil and copper are already declining, and so do their producers.

Top in Interest Rates or Top in Gold? - Image 6

This is not a sign of an economic upturn – quite the opposite.

And yes, yesterday’s decline means that the profits on our short positions in the FCX (entered in early April) increased once again.

What does all the above imply for the forecast for gold prices?

Gold has two primary fundamental drivers. One is the USD Index (so, the forex price moves are important), and the other is the real (!) interest rate.

As I explained above, the real interest rates are likely to go higher, which means that gold is likely to go lower. The reason why gold moved higher in the previous months is likely due to the overall situation on the market – the move from the “bull trap” to the “return to normal” stage of the bear market. And now – with the following moves in interest rates and inflation, it’s likely to become clear what is really happening and what’s not.

So, yes, gold is likely to slide as well.

However, silver and junior mining stocks are likely to take most of the burden due to their links with the general stock market.

Silver is widely used in the industry, so falling industrial demand is likely to negatively affect the silver price projection; and junior mining stocks have proven to be particularly linked to the general stock market many times in the past. Remember the 2020 slide? Junior miners declined the most.

Top in Interest Rates or Top in Gold? - Image 7

Please note that junior mining stocks moved only slightly higher yesterday despite a quite notable daily upswing in gold. Junior miners’ weakness relative to gold is one of the bottom-up signs (as opposed to the top-down signs like aligning the situation with the general cycles of bull/bear markets) pointing to lower precious metals values in the following weeks.

Top in Interest Rates or Top in Gold? - Image 8

For comparison, gold moved notably higher, and it moved even higher in the overnight trading (that’s not visible on the above chart). Yet, the GDXJ is only slightly up in today’s London trading.

So, all in all, I’d view this week’s upswing as something temporary and not really sustainable. The profits on the short positions in FCX are likely to increase further, and the precious metals sector is likely to join in this decline, too. In particular, in my view, the downside potential for junior mining stocks is enormous at this time.

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Przemyslaw Radomski, CFA
Founder, Editor-in-chief