Who's Afraid of the Big Bad Fed? Gold Shouldn't Be
by Adrian Day
To say that the Federal Reserve, as well as other major central banks, have been acting like drunken sailors in recent years is an insult to the inebriated seamen. }
The huge increases in global liquidity have been driving markets.
Stocks, real estate, bitcoin, bonds (of course), and even strange concoctions called NFTs have all benefitted from the massive increase in the money supply.
The exception of late appears to be gold—the asset one would have expected to be the prime beneficiary.
Why has gold not responded more?
Gold investors are asking why gold is not higher given the unprecedented money printing and rising inflation, as well as when that might change.
Certainly, if we go back to when the new age of money printing began, after the 2008 credit crisis (when gold was at $718), or just look at the period since the COVID-induced money mania (with gold at $1,471), we can say that gold has, in fact, responded.
But certainly, in recent months, it has frustrated gold investors and is down nearly 8% so far this year, even as the money printing continues and inflation has entered the public consciousness.
Why is this?
To some extent, gold has simply been in a long consolidation after the extraordinary move early last year, when gold jumped over 30% from its end-March low to early-August high (the gold stocks more than doubled).
That kind of move—in only four months—is extraordinary for an asset that is intended as a hedge and insurance.
Gold is not supposed to do that.
Bitcoin or Tesla perhaps, but not gold! Since then, it has been a long consolidation, as month-by-month more and more people give up, while potential buyers feel there is no rush to invest.
Gold always has deep mid-cycle corrections
This year’s performance has been disheartening, but we should put it in context: Gold was up 25% last year, so the pullback is less than one-third of the previous year’s move up.
The current gold bull market started at the end of 2015 when gold hit $1,051.
So gold is up 70% in six years.
Sometimes, I think we expect too much from gold and are never satisfied.
Gold cycles, both up and down, tend to be long.
The shortest has been the last two—in the 1970s and from 2001 to 2011.
Also, it is not unusual for gold to have mid-cycle corrections, often caused by an extraneous shock.
In the 1970s, gold dropped over 40% in a correction lasting 20 months.
In 2008’s credit crisis, it fell nearly 30% in eight months.
So far, this pullback has taken 15% off gold’s peak price—a piker by historical standards—and has lasted just 13 months—well within norms for mid-cycle corrections.
I would suggest that gold bottomed in March at $1,685, meaning the correction lasted less than seven months.
Strength in the dollar and stock market is an anchor on gold
There have been fundamental factors holding back gold, and three are the most important.
One is the dollar, which has moved up over the past several months as the "cleanest shirt in the laundry basket."
However, as low as U.S. interest rates might be, they remain meaningfully higher than those offered by other major world currencies.
The second factor is that the stock market and other assets—including cryptocurrencies—have been doing well.
As long as the stock market moves up, investors believe that gold investments can wait.
The third major factor holding back gold is the Federal Reserve’s constant threat to start tapering.
The Fed has a history of talking more than doing and, for reasons beyond me, still has credibility.
It is not only gold that has not responded to money printing and inflation, but other assets all seem to be buying the Fed’s narrative.
Of course, tighter monetary policy, other things being equal, is a negative for gold.
But should we be so worried?
The Fed’s bark is worse than its bite
The Fed has been talking about tapering for months now, but it has constantly been pushing back on actually doing anything.
The story changes day by day, but two things are clear.
First, they will have to cut back on new purchases at some point; and second, they are extremely hesitant to actually do anything meaningful.
Even after FedHead Jerome Powell said last month after the Fed’s last meeting that they would commence tapering in December—itself a postponement of previous expectations—he has started walking it back, talking of "supply-side constraints holding back the economy…not getting better…the outlook is highly uncertain."
That does not sound like a Fed chairman determined to start the tapering process soon (and one fighting for re-nomination).
Powell talks about supply-side constraints, but if he is looking for a reason (or excuse) to postpone tapering again, there is no shortage of those: the looming "ESG recession" in Europe; the pending Evergrande default in China; another (unexpected?) jump in new unemployment claims, as well as an economy losing some steam rapidly.
The Fed also fired (allowed to retire) two regional Fed chairmen caught conducting personal trades. By coincidence (?), these were the two most hawkish—or rather "least dovish"—of Fed officials and can now be replaced by accommodative Biden appointees.
Let’s be clear about a couple of things.
First, tapering is only reducing the pace of new purchases; it is not selling anything.
So the Fed’s balance sheet, which has continued to grow at an accelerating pace the last couple of months (24% in the last three months compared with 19% in the last 12 months), even as they discuss tapering, will still be larger a year from now than it is today.
Second, as Powell himself made very clear in his Jackson Hole speech at the end of August, the Fed is separating tapering from raising interest rates.
The Fed won’t be raising rates any time soon.
It is going to be a while—at least 2023, I think—before the Fed increases rates, and even then, it will lag behind inflation.
The Fed under Powell emphasizes data, and by its nature, this is backward-looking.
This is in addition to the extreme reluctance of the Fed to upset the apple cart.
This is why Fed jawboning has more effect than action.
The Fed threatening tightening makes investors nervous.
Any cut back is, per se, a negative for the bond market, but not so for gold.
Once they actually start tightening, the market sees that what the Fed is doing is never sufficient and rises.
The fact is that, many times in the past, gold has moved down in advance of Federal Reserve tightening, responding to growing talk, only to bottom and turn when it actually started to tighten.
Gold acts this way because, all too often, when the Fed does actually start to act, it is too little too late.
The Fed started raising rates in August 2005, tapering in December 2013, and raising rates again in December 2015, each time after months of discussion.
Gold bottomed in the same month each tightening action started.
In May 2013, when the Fed started talking about tapering, gold slid for several months, only to bottom almost to the day that the Fed started reducing its new asset purchases.
It rose over 16% in the next three months, and the stocks jumped by 32%.
This was in the context of an ongoing bear market for gold.
The gold stocks are extraordinarily undervalued
If bullion has disappointed gold holders, then that story is all the more true for gold stocks.
The major miners (per the XAU) more than doubled in the end-March to early-August period last year, so they too have experienced a long consolidation.
Why should generalist investors be in any rush to buy gold stocks when they lost money on the sector last time and everything else they own is going up?
The stocks are now extraordinarily inexpensive, with the senior and intermediate gold companies trading in the lowest 25 percentile of their historical valuations, and more or less the lowest price-to-free cash flow ever.
Given the price of gold, the strong cash flows, the improved balance sheets (the XAU is net cash positive today), and the improved discipline among top mining companies, today’s low valuations are a gift.
We all know that gold stocks are volatile.
But that volatility works both ways, and once gold starts to move up convincingly, then the gold stocks will respond very strongly.
It is worth noting that flows into gold ETFs and other investment vehicles are very procyclical, so we can expect flows to increase as the gold price moves up.
The recent action has been frustratingly modest and volatile.
However, the longer gold meanders in its current trading range, the faster and stronger the eventual move will be.
In the meantime, gold investors can accumulate at prices that will appear very good in a few years’ time.
They should not wait too long.
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