Sive Morten
Special Consultant to the FPA
- Messages
- 18,664
Fundamentals
This week we have a kind of combination of political and economical news, that are important, but, maybe do not have direct and immediate impact on the markets. Changing rhetoric of EU regulation authorities concerning frozen Russian assets indirectly points on changing vector in foreign policy, as situation on Ukrainian battlefield is changing. Recent J. Powell speech suggests the worst scenario, when Fed intends to do nothing but go with the flow, plugging wholes when necessary. Now they are neither hawkish nor dovish. Correspondingly they could neither crash inflation nor stimulate consumption. That's why, J. Yellen recent comments sound evil -
Otherwise, speaking, the US households prosperity is a kind of sacrifice on altar of inflation. The American consumer must become a victim in the fight against rising prices, and the main thing for the regulator is to achieve the necessary macroeconomic indicators.
Market overview
Gold prices on Friday were heading for their biggest weekly percentage fall in over four months, weighed by a stronger dollar and hawkish comments by Federal Reserve officials. The dollar strengthened after Fed Chair Jerome Powell, in congressional testimony this week, signaled more interest rate hikes ahead but vowed the central bank would proceed with caution.
San Francisco Fed Bank President Mary Daly said on Friday in an interview with Reuters that two more rate hikes this year is a "very reasonable" projection. Higher U.S. interest rates increase the opportunity cost of holding gold. Bullion has fallen nearly 2% so far this week and has lost more than $150 since scaling above the key $2,000 level in early May.
Gold-focused ETFs have resumed their decline. For 13 consecutive days, the stocks in the funds have been declining, which brings them to the level before the bankruptcy of SVB bank. With hawkish signals from central banks, high real rates can be expected to hurt gold. Given the technical weakness of the commodity, the risks for gold are growing.
️Gold is usually seen as a hedge against inflation. Conventional wisdom says that an ounce of gold can buy about the same amount of bread as in the days of Babylon. (For reference, the answer is 350 loaves). But nowadays, owning and storing gold comes with a cost. Which means that the metal becomes very sensitive to changes in real yield.
At the end of 2021, 10-year TIPS returns were below -1%. Today they are above 1.5%. Thus, in the absence of demand for insurance against financial Armageddon (the other main use case for gold), investors should logically continue to sell the metal, which should lead to a decrease in the price of gold.
A bit more about the Fed
Here is opinion of P. Schiff team, mostly they confirm what we've said yesterday - Powell is trying to sit on two chairs. The Fed chief engaged in some more open-mouth operations, trying to guide monetary policy with words instead of actions. To understand a few things he said, you have to read between the lines. Besides, he also got at least a couple of things wrong along the way.
During his testimony on Capitol Hill, Powell doubled down on the hawkishness, saying, “Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.” He also insisted that the skipped rate was not a “pause.”
The Fed chair also offered a little analogy.
There is clearly a disconnect between what the Fed is doing and what Powell is saying. After all, if the Fed was really that hawkish, why skip a rate hike? Mises Institute executive editor Ryan McMaken summed it up, saying Powell wants to have it both ways.
Powell made a couple of comments that you need to read between the lines to fully appreciate. The Fed chair said, “We want to get back to price stability, want to get back to that place where inflation is low enough that people don’t think about it.”
In other words, the central bank wants to keep devaluing the dollar, but not so fast that you feel the pain on a daily basis. The Fed prefers a “boil the frog slowly” approach so you don’t notice that it is taking away your purchasing power year after year. In other words, keep the inflation tax low enough so as not to upset the masses. Consider this: at 2% inflation, you lose 10% of your purchasing power every five years.
And that’s the target.
Powell also said “Inflation has consistently surprised us, and essentially all other forecasters, by being more persistent than expected. And I think we’ve come to expect that — expect it to be more persistent.” In other words, we’re not very good at our jobs. Remember when Powell and Company were insisting that “inflation is transitory?” It wasn’t until December 2021 that government officials finally conceded inflation wasn’t transitory. I was saying this at least six months earlier. You will note that I am not a Fed official. How was it that I wasn’t surprised but the “experts” who are running the economy were?
Finally Powell got at least two things wrong during his chat with the Financial Services Committee. First, he claimed, “A very strong labor market is driving the economy.”
Wrong! In the first place, a lot of the job data simply doesn’t add up. And whatever real strength exists in the labor market is the result of a weak economy, high price inflation, and falling real wages that are driving people to take on extra work in order to make ends meet.
Price inflation is eating everybody’s lunch, and more and more people are taking on part-time work (part-time jobs count as jobs) with many even opting for a second full-time job. Meanwhile, retirees are being forced to return to the workforce because inflation is ravaging their fixed incomes. This is not a sign of a “robust” economy. It’s a sign of economic desperation.
Second, Powell totally sidestepped the root cause of global price inflation, calling “the pandemic” the “common factor” driving prices higher. Wrong! The pandemic – or more accurately, the government response to the pandemic – was certainly part of the equation. But the real common factors were central bank policies of artificially low interest rates and quantitative easing, along with government deficit spending.
And this started long before the pandemic. Central banks around the world pumped trillions of dollars of new money into the global economy in the wake of the 2008 financial crisis. The Federal Reserve held rates at zero for years and some central banks, including the European Central Bank and the Bank of Japan, introduced negative interest rate policies.
Of course, central banks doubled down on these easy money policies during the pandemic, pumping trillions of additional dollars into the economy. This is the root cause of price inflation, not COVID-19. By pinning price inflation on the “pandemic” in the abstract, Powell shifts blame away from the real culprit – the man looking back at him in the mirror every morning and his fellow central bankers.
Long term Gold perspective still looks attractive
Indeed, the monthly mortgage payment for the average new loan has doubled since the start of last year to nearly $3,000. As households continue to draw down their excess savings, these higher mortgage payments will eventually start to have a negative impact on the housing market and consumers. In short, they do not let the market fall. But when the excess savings run out by the end of the year...
With this background it is unclear who will buy all new "Housing starts" and "Building permits". Commercials? According to the Mortgage Bankers Association, $1.4 Trln should be returned for 2023 - 2024. When the time comes, many owners may choose to default rather than take on new debt to pay off old ones, especially with rates above 6%. Since March 2022, the cost of offices in the US has fallen by 27%.
According to Capital Economics, the drop from the pre-Covid peak should be 35%, and the recovery of the US office real estate market should not be expected until 2040. According to MSCI Real Assets, $43 billion worth of office buildings are at risk of default in the near term. Of course, all this may turn out to be just another story from the category of “a boy and wolves”. The good Fed will come, print another infinity of money and save everyone. But there is still a small chance of a domino effect, since in 2008 some were not rescued.
Recent US bank regulations and capital requirements adding insult to injury to already fragile lenders sitting on weak legacy loans and simultaneous credit contraction. Adding to this irony is the rise in new home construction permits which fail to ask the question of who will be buying such properties as real estate, like autos, head toward a “negative equity iceberg.” This current café society calm, however, ignores the inevitable consequences of rising rates and undefeated inflation whose longer-term economic pressures, lagging for now, will emerge with crippling force in the months ahead. In the end, all broke governments become the best of friends to precious metal investors, for the historically-confirmed reason that all broken regimes always debase their currencies.
All these things that we see here confirms our bullish long term view on Gold market. Sooner or later but slow rusting processes beneath the curtain will come on surface. Fed does nothing, taking tactical decision, trying to satisfy markets. This week market was more or less calm, because US Treasury was quiet, without big new borrowing. But soon this will happen. And that might be the first test. They still have 2-3 times larger sources, where they could get necessary money. But this is only for this year. Where they will get funds for next year - that's the question.
The Biden administration is blowing through about $500 billion every single month. This pace isn’t about to slow down despite what you might have heard about spending cuts in the “Fiscal Responsibility Act.” That means we can expect more massive monthly budget deficits. On the other side of the ledger, government receipts are falling. In May, the Treasury reported inflows of $307.5 billion. That was a 26.5% drop from May 2022. Receipts fall, and government tax revenue will decline even faster if the economy spins into a recession.
The sheer size of the debt isn’t the only problem. The interest payments on that debt are growing exponentially. The trailing 12-month (TTM) interest on the debt clocked in at just under $600 billion in May. This was up from $350 billion at the start of 2022, less than 18 months ago. The government has added an extra $250 billion in expenses per year on just debt service.
This is just the beginning of an upward trend. Based on the current interest payment, The Treasury is paying less than 2% interest for now. But a lot of the debt currently on the books was financed at very low rates before the Federal Reserve started its hiking cycle. Every month, some of that super-low-yielding paper matures and has to be replaced by bonds yielding much higher rates. That means interest payments will quickly climb much higher unless rates fall.
If interest rates remain elevated or continue rising, interest expenses could climb rapidly into the top three federal expenses. If the national debt climbs to $40 trillion (and given the current deficits it won’t take long) and interest rates remain at 5% (which Jerome Powell says will be necessary to tackle inflation) interest payments on the debt alone would skyrocket around $2 trillion per year. let’s assume the federal government can maintain the current deficit level of around $1 trillion annually (minus interest expense). Even with this overly-optimistic scenario, the Treasury would be running a $3 trillion annual budget deficit. What to do with the rates? Cut? Let's take it closer:
Option 1: The Fed beat inflation (in fact, no, and again no, but let's assume) GDP stagnates or fell, debt also stopped growing, but remained large. Weight on the legs, which still interferes with life and the risk of default remains.
Option 2: The Fed does not even try to beat inflation, but actually accelerates it (the rhetoric here is exactly the same as with Ukraine or China - the opposite of what is actually happening). In this case, inflation eases the debt burden, and if we manage to make it double-digit for a long time, in general, in a few years, you can start life from scratch. No defaults, and completely controlled media will talk the people into stupefaction. In the end, it worked out with the Second World War, it will work out here too. Yes, the issue income associated with the status of the dollar as the world reserve currency disappears, but firstly, not totally, secondly, not immediately, and thirdly, look at China - the same problems are there. In general, subjectively, the second option is more viable. Therefore, elections or not, but it seems that the rate will be raised and the banks will also drop.
Since 2014, it has become harder to export Uncle Sam’s inflation (or launder its debt burdens) by expecting other nations to simply absorb his increasingly unwanted USTs and openly embarrassing bar tab. As the following graph provided by Luke Gromen makes “clear, all too clear,” the gap between Uncle Sam’s embarrassing deficit (blue line) and the meek level of foreign buyers of his debt (red line) reveals two historical points:
Notwithstanding the otherwise undeniable and changing patterns in the aforementioned global FX and geopolitical stage, one merely has to consider the seemingly unlimited supply of otherwise unwanted USTs with their intrinsically limited duration and then compare such toxicity with a simple bar of gold, which, unlike Uncle Sam’s IOUs, has an infinite duration and limited supply.
In short: Supply and demand still matter. Toward this end, it’s worth noting that gold discoveries are shrinking in supply as demand for the same is, and will continue, to rise. In the 1990’s, for example, there were over 180 major gold discoveries (i.e., 1m oz. and higher); in the 2000’s there were 120 such discoveries, 40 in the 2010’s and NONE since 2019. Think about that for a second or two.
Also, think about the simple fact that Uncle Sam, the holder of the world reserve currency, has been hiking rates into the greatest debt bubble in once proud national history, thereby increasing US solvency risk (and thus pointing toward dollar debasement down the road) with neon-flashing clarity.
Gold, quite simply, is separating from real rates and acting more and more on its own, as the fear trade gets easier and easier to see, and gold gets easier and easier to, well…TRUST.
Thus, we repeat and repeat this again, that current levels are interesting for gradual gold accumulation and long-term investments in physical gold - coins, bars, bullions etc. Although under the current circumstances, gold remains under pressure which will last for some time more.
At the end of the report, we would like to mentioned the changes in rhetoric of ECB, concerningconfiscated frozen Russian assets. The European Union has assessed that it can’t legally confiscate outright frozen Russian assets and instead is focusing on using those assets temporarily, according to a document obtained by Bloomberg. It could mean that the ice has broken. Since the EU has taken care of legal grounds, then the illusions about an imminent military victory have dissipated. In addition, we were talking about a "voluntary" contribution, and not confiscation or otherwise, which means there are chances that you will have to unfreeze assets and return the money (by the way, those who have earned on confiscated assets and made a voluntary contribution in favor of Ukraine can still run into courts and end up paying twice. In general, one gets the impression that the "steel hand in a kid glove" is urgently looking for toilet paper 
Of course, all this is just the beginning and the situation may unfold several times, but the symptom itself deserves attention. And yes, appreciate how the rhetoric has changed in just over a year.
This week we have a kind of combination of political and economical news, that are important, but, maybe do not have direct and immediate impact on the markets. Changing rhetoric of EU regulation authorities concerning frozen Russian assets indirectly points on changing vector in foreign policy, as situation on Ukrainian battlefield is changing. Recent J. Powell speech suggests the worst scenario, when Fed intends to do nothing but go with the flow, plugging wholes when necessary. Now they are neither hawkish nor dovish. Correspondingly they could neither crash inflation nor stimulate consumption. That's why, J. Yellen recent comments sound evil -
Otherwise, speaking, the US households prosperity is a kind of sacrifice on altar of inflation. The American consumer must become a victim in the fight against rising prices, and the main thing for the regulator is to achieve the necessary macroeconomic indicators.
Market overview
Gold prices on Friday were heading for their biggest weekly percentage fall in over four months, weighed by a stronger dollar and hawkish comments by Federal Reserve officials. The dollar strengthened after Fed Chair Jerome Powell, in congressional testimony this week, signaled more interest rate hikes ahead but vowed the central bank would proceed with caution.
San Francisco Fed Bank President Mary Daly said on Friday in an interview with Reuters that two more rate hikes this year is a "very reasonable" projection. Higher U.S. interest rates increase the opportunity cost of holding gold. Bullion has fallen nearly 2% so far this week and has lost more than $150 since scaling above the key $2,000 level in early May.
Gold-focused ETFs have resumed their decline. For 13 consecutive days, the stocks in the funds have been declining, which brings them to the level before the bankruptcy of SVB bank. With hawkish signals from central banks, high real rates can be expected to hurt gold. Given the technical weakness of the commodity, the risks for gold are growing.
️Gold is usually seen as a hedge against inflation. Conventional wisdom says that an ounce of gold can buy about the same amount of bread as in the days of Babylon. (For reference, the answer is 350 loaves). But nowadays, owning and storing gold comes with a cost. Which means that the metal becomes very sensitive to changes in real yield.
At the end of 2021, 10-year TIPS returns were below -1%. Today they are above 1.5%. Thus, in the absence of demand for insurance against financial Armageddon (the other main use case for gold), investors should logically continue to sell the metal, which should lead to a decrease in the price of gold.
A bit more about the Fed
Here is opinion of P. Schiff team, mostly they confirm what we've said yesterday - Powell is trying to sit on two chairs. The Fed chief engaged in some more open-mouth operations, trying to guide monetary policy with words instead of actions. To understand a few things he said, you have to read between the lines. Besides, he also got at least a couple of things wrong along the way.
During his testimony on Capitol Hill, Powell doubled down on the hawkishness, saying, “Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.” He also insisted that the skipped rate was not a “pause.”
The Fed chair also offered a little analogy.
There is clearly a disconnect between what the Fed is doing and what Powell is saying. After all, if the Fed was really that hawkish, why skip a rate hike? Mises Institute executive editor Ryan McMaken summed it up, saying Powell wants to have it both ways.
He went on to say the reason for this muddled messaging “is not completely mysterious.” We've also pointed few times on some nervousness of J. Powell in recent two meetings, pointing that next rate decision is more a political step rather than economical, because it could lead to the changes in economy of such scale that it makes direct impact on loyalty to government among population.
Powell made a couple of comments that you need to read between the lines to fully appreciate. The Fed chair said, “We want to get back to price stability, want to get back to that place where inflation is low enough that people don’t think about it.”
In other words, the central bank wants to keep devaluing the dollar, but not so fast that you feel the pain on a daily basis. The Fed prefers a “boil the frog slowly” approach so you don’t notice that it is taking away your purchasing power year after year. In other words, keep the inflation tax low enough so as not to upset the masses. Consider this: at 2% inflation, you lose 10% of your purchasing power every five years.
And that’s the target.
Powell also said “Inflation has consistently surprised us, and essentially all other forecasters, by being more persistent than expected. And I think we’ve come to expect that — expect it to be more persistent.” In other words, we’re not very good at our jobs. Remember when Powell and Company were insisting that “inflation is transitory?” It wasn’t until December 2021 that government officials finally conceded inflation wasn’t transitory. I was saying this at least six months earlier. You will note that I am not a Fed official. How was it that I wasn’t surprised but the “experts” who are running the economy were?
Finally Powell got at least two things wrong during his chat with the Financial Services Committee. First, he claimed, “A very strong labor market is driving the economy.”
Wrong! In the first place, a lot of the job data simply doesn’t add up. And whatever real strength exists in the labor market is the result of a weak economy, high price inflation, and falling real wages that are driving people to take on extra work in order to make ends meet.
Price inflation is eating everybody’s lunch, and more and more people are taking on part-time work (part-time jobs count as jobs) with many even opting for a second full-time job. Meanwhile, retirees are being forced to return to the workforce because inflation is ravaging their fixed incomes. This is not a sign of a “robust” economy. It’s a sign of economic desperation.
Second, Powell totally sidestepped the root cause of global price inflation, calling “the pandemic” the “common factor” driving prices higher. Wrong! The pandemic – or more accurately, the government response to the pandemic – was certainly part of the equation. But the real common factors were central bank policies of artificially low interest rates and quantitative easing, along with government deficit spending.
And this started long before the pandemic. Central banks around the world pumped trillions of dollars of new money into the global economy in the wake of the 2008 financial crisis. The Federal Reserve held rates at zero for years and some central banks, including the European Central Bank and the Bank of Japan, introduced negative interest rate policies.
Of course, central banks doubled down on these easy money policies during the pandemic, pumping trillions of additional dollars into the economy. This is the root cause of price inflation, not COVID-19. By pinning price inflation on the “pandemic” in the abstract, Powell shifts blame away from the real culprit – the man looking back at him in the mirror every morning and his fellow central bankers.
Long term Gold perspective still looks attractive
Indeed, the monthly mortgage payment for the average new loan has doubled since the start of last year to nearly $3,000. As households continue to draw down their excess savings, these higher mortgage payments will eventually start to have a negative impact on the housing market and consumers. In short, they do not let the market fall. But when the excess savings run out by the end of the year...
With this background it is unclear who will buy all new "Housing starts" and "Building permits". Commercials? According to the Mortgage Bankers Association, $1.4 Trln should be returned for 2023 - 2024. When the time comes, many owners may choose to default rather than take on new debt to pay off old ones, especially with rates above 6%. Since March 2022, the cost of offices in the US has fallen by 27%.
According to Capital Economics, the drop from the pre-Covid peak should be 35%, and the recovery of the US office real estate market should not be expected until 2040. According to MSCI Real Assets, $43 billion worth of office buildings are at risk of default in the near term. Of course, all this may turn out to be just another story from the category of “a boy and wolves”. The good Fed will come, print another infinity of money and save everyone. But there is still a small chance of a domino effect, since in 2008 some were not rescued.
Recent US bank regulations and capital requirements adding insult to injury to already fragile lenders sitting on weak legacy loans and simultaneous credit contraction. Adding to this irony is the rise in new home construction permits which fail to ask the question of who will be buying such properties as real estate, like autos, head toward a “negative equity iceberg.” This current café society calm, however, ignores the inevitable consequences of rising rates and undefeated inflation whose longer-term economic pressures, lagging for now, will emerge with crippling force in the months ahead. In the end, all broke governments become the best of friends to precious metal investors, for the historically-confirmed reason that all broken regimes always debase their currencies.
All these things that we see here confirms our bullish long term view on Gold market. Sooner or later but slow rusting processes beneath the curtain will come on surface. Fed does nothing, taking tactical decision, trying to satisfy markets. This week market was more or less calm, because US Treasury was quiet, without big new borrowing. But soon this will happen. And that might be the first test. They still have 2-3 times larger sources, where they could get necessary money. But this is only for this year. Where they will get funds for next year - that's the question.
The Biden administration is blowing through about $500 billion every single month. This pace isn’t about to slow down despite what you might have heard about spending cuts in the “Fiscal Responsibility Act.” That means we can expect more massive monthly budget deficits. On the other side of the ledger, government receipts are falling. In May, the Treasury reported inflows of $307.5 billion. That was a 26.5% drop from May 2022. Receipts fall, and government tax revenue will decline even faster if the economy spins into a recession.
The sheer size of the debt isn’t the only problem. The interest payments on that debt are growing exponentially. The trailing 12-month (TTM) interest on the debt clocked in at just under $600 billion in May. This was up from $350 billion at the start of 2022, less than 18 months ago. The government has added an extra $250 billion in expenses per year on just debt service.
This is just the beginning of an upward trend. Based on the current interest payment, The Treasury is paying less than 2% interest for now. But a lot of the debt currently on the books was financed at very low rates before the Federal Reserve started its hiking cycle. Every month, some of that super-low-yielding paper matures and has to be replaced by bonds yielding much higher rates. That means interest payments will quickly climb much higher unless rates fall.
If interest rates remain elevated or continue rising, interest expenses could climb rapidly into the top three federal expenses. If the national debt climbs to $40 trillion (and given the current deficits it won’t take long) and interest rates remain at 5% (which Jerome Powell says will be necessary to tackle inflation) interest payments on the debt alone would skyrocket around $2 trillion per year. let’s assume the federal government can maintain the current deficit level of around $1 trillion annually (minus interest expense). Even with this overly-optimistic scenario, the Treasury would be running a $3 trillion annual budget deficit. What to do with the rates? Cut? Let's take it closer:
Option 1: The Fed beat inflation (in fact, no, and again no, but let's assume) GDP stagnates or fell, debt also stopped growing, but remained large. Weight on the legs, which still interferes with life and the risk of default remains.
Option 2: The Fed does not even try to beat inflation, but actually accelerates it (the rhetoric here is exactly the same as with Ukraine or China - the opposite of what is actually happening). In this case, inflation eases the debt burden, and if we manage to make it double-digit for a long time, in general, in a few years, you can start life from scratch. No defaults, and completely controlled media will talk the people into stupefaction. In the end, it worked out with the Second World War, it will work out here too. Yes, the issue income associated with the status of the dollar as the world reserve currency disappears, but firstly, not totally, secondly, not immediately, and thirdly, look at China - the same problems are there. In general, subjectively, the second option is more viable. Therefore, elections or not, but it seems that the rate will be raised and the banks will also drop.
Since 2014, it has become harder to export Uncle Sam’s inflation (or launder its debt burdens) by expecting other nations to simply absorb his increasingly unwanted USTs and openly embarrassing bar tab. As the following graph provided by Luke Gromen makes “clear, all too clear,” the gap between Uncle Sam’s embarrassing deficit (blue line) and the meek level of foreign buyers of his debt (red line) reveals two historical points:
- US deficits are appalling;
- Who or what is going to fill that “gap”?
Notwithstanding the otherwise undeniable and changing patterns in the aforementioned global FX and geopolitical stage, one merely has to consider the seemingly unlimited supply of otherwise unwanted USTs with their intrinsically limited duration and then compare such toxicity with a simple bar of gold, which, unlike Uncle Sam’s IOUs, has an infinite duration and limited supply.
In short: Supply and demand still matter. Toward this end, it’s worth noting that gold discoveries are shrinking in supply as demand for the same is, and will continue, to rise. In the 1990’s, for example, there were over 180 major gold discoveries (i.e., 1m oz. and higher); in the 2000’s there were 120 such discoveries, 40 in the 2010’s and NONE since 2019. Think about that for a second or two.
Also, think about the simple fact that Uncle Sam, the holder of the world reserve currency, has been hiking rates into the greatest debt bubble in once proud national history, thereby increasing US solvency risk (and thus pointing toward dollar debasement down the road) with neon-flashing clarity.
Gold, quite simply, is separating from real rates and acting more and more on its own, as the fear trade gets easier and easier to see, and gold gets easier and easier to, well…TRUST.
Thus, we repeat and repeat this again, that current levels are interesting for gradual gold accumulation and long-term investments in physical gold - coins, bars, bullions etc. Although under the current circumstances, gold remains under pressure which will last for some time more.
At the end of the report, we would like to mentioned the changes in rhetoric of ECB, concerning
Of course, all this is just the beginning and the situation may unfold several times, but the symptom itself deserves attention. And yes, appreciate how the rhetoric has changed in just over a year.
