Gold
largely ignored inflation raging out of control in 2022. Despite
the first inflation super-spike since the 1970s, history’s ultimate
inflation hedge disappointed. But that unsustainable anomaly driven
by extreme Fed rate hikes catapulting the US dollar parabolic won’t
last. Inevitably prevailing gold prices will adjust much higher to
reflect this red-hot inflation fueled by epic money-supply growth.
That’s very bullish for 2023.
During this past year, the primary US inflation gauge recorded
extremes not seen in four decades. The monthly headline
Consumer Price Index averaged blistering 8.1% year-over-year surges,
never printing lower than 7.1%. June 2022’s staggering 9.1% peak
proved the hottest CPI since way back in November 1981, fully 40.6
years earlier! And the CPI has been heavily watered down since,
lowballed for political reasons.
Such
serious inflation should’ve lit a fire under gold, fueling massive
investment demand. Gold got off to a strong start in 2022, surging
up 12.1% year-to-date in early March. But that was a geopolitical
spike on Russia invading Ukraine, which wasn’t sustainable. From
there gold collapsed 20.9% over the next 6.6 months into late
September. That left it down a shocking 11.3% YTD in the worst
inflation year since 1981!
That
gaping
gold-inflation disconnect made no sense, leaving investors
increasingly bearish. But gold’s brutal mid-2022 plunge was an
extreme anomaly driven by the Fed scrambling to stuff that inflation
genie back in the bottle. Between mid-March to early November, the
Federal Open Market Committee hiked its federal-funds rate an
astounding 375 basis points. That included a shocking streak of
four monster 75bp hikes!
As
those frantic
rate hikes accelerated, the benchmark US Dollar Index
skyrocketed up 14.3% between mid-April to late September to hit a
stunning 20.4-year secular high. That unleashed
enormous
gold-futures selling, slamming gold 17.9% lower in that span.
That accounted for 6/7ths of its mid-year plunge, and had
nothing to do with inflation. But it exhausted gold-futures
speculators’ capital firepower for selling.
So
gold bounced strongly since, powering up as much as 12.1% into late
December despite another big 50bp Fed rate hike! With major
gold-futures mean-reversion buying underway, that
selloff anomaly
has passed. That clears the way for gold to start reflecting
this raging inflation. Ironically that wasn’t spawned by the Fed’s
zero-interest-rate policy after the pandemic-lockdown stock panic,
but the Fed’s epic money printing.
Between late February 2020 to mid-April 2022, the Fed ballooned its
balance sheet a shocking 115.6% higher! It brazenly conjured
$4,807b of new fiat dollars out of thin air in just 25.5 months to
monetize US Treasuries and mortgage-backed bonds! That more than
doubled the US-dollar supply in just a couple years, seeding the
subsequent raging inflation. Money supplies are what drive general
price levels, not rates.
Legendary American economist Milton Friedman proved this in the
early 1960s, after studying and writing his massive opus “A Monetary
History of the United States”. From those pages sprung his
most-famous quote, “Inflation is always and everywhere a monetary
phenomenon.” Relatively-more money bidding up the prices on
relatively-less goods and services is the root cause of inflation,
which is the Fed’s responsibility.
Hiking its federal-funds rate an exceedingly-aggressive 425 basis
points in just 9 months this year can’t slay inflation. Instead the
Fed has to destroy the lion’s share of that $4,807b of new dollars
that it created in its fourth quantitative-easing campaign. That
process has begun with the Fed’s second quantitative-tightening one,
but it remains small. As of late December, QT2 has only reversed
1/13th of QE4 so far!
The
Fed’s balance sheet remains grotesquely bloated, $4,406b higher than
before March 2020’s stock panic. QT2 is supposed to be running at
$95b per month of monetary destruction, but so far has only averaged
$71b. Even if the Fed finds the courage to ramp QT2 to that
promised pace, it would still take over 46 more months to
fully unwind QE4’s vast monetary deluge or 23+ months to merely
reverse half!
So
that epic flood of new QE4 money is going to continue sloshing
around the US economy for years. No matter how high the Fed
hikes rates, big inflation will persist with a monetary base still
105.9% higher than pre-panic levels. That’s super-bullish for gold,
which is history’s ultimate inflation hedge because of its
naturally-constrained mined-supply growth. That only grows on the
order of 1% annually, far less than money.
This
chart overlays gold and its key technicals on the monthly headline
CPI’s year-over-year changes in the last few years. Gold is
dramatically lagging this biggest inflation super-spike since
the 1970s, which has really vexed investors. But that is changing
as gold-futures speculators normalize their excessively-bearish bets
spawned by mid-2022’s parabolic US-dollar surge. Gold will
increasingly reflect inflation in 2023!
No
bones about it, gold’s performance during this latest Fed-spawned
inflation super-spike has been poor to dreadful. Though an extreme
pandemic-lockdown distortion, the trough CPI came in May 2021 up a
trivial 0.1% YoY. That month gold averaged $1,850 on close.
Despite inflation soaring vertical since then, gold has only
averaged $1,795 so far this month. That’s down 3.0% through this
inflation super-spike!
But
it gets worse, as without lockdowns the CPI trough would’ve likely
hit in November 2020 up just 1.2% YoY. Gold averaged $1,868 then,
making for a 3.9% loss since. That’s incredibly disappointing,
contrary to all historical precedent. With the worst inflation
raging since 1981 at the tail end of the previous super-spike,
gold probably should’ve doubled by now. That would have made
for $3,750ish monthly-average prices!
Gold
reacting so powerfully to an inflation super-spike may sound crazy,
but it’s actually conservative. In the entire modern monetary era
since August 1971 when the US dollar was severed from its gold
standard, there have only been three inflation super-spikes. Gold
did far better than doubling during the first two back in the
1970s. Investors flocked to it as inflation ravaged stocks and
eroded dollar purchasing power.
That’s certainly evident in this next real gold chart, comparing
CPI-inflation-adjusted gold prices to the monthly headline CPI
prints during that 1970s decade. Gold prices are rendered in
constant November 2022 dollars per the latest CPI, making them
comparable with today’s. But all the gold upleg gains and
correction losses are noted in actual nominal terms. Gold was a
moonshot in those last inflation super-spikes!
The
first inflation super-spike ran between June 1972’s CPI trough up
2.7% YoY to December 1974’s peak soaring 12.3% higher. During that
30-month span, monthly-average gold prices from those trough to peak
CPI months soared up 196.6%! Gold nearly tripled during that
first inflation super-spike soon after the dollar gold standard was
slain. Investors wisely used gold to protect their capital from
inflation’s predations.
The
second much-larger inflation super-spike erupted right on its heels,
spawning at November 1976’s +4.9% YoY CPI trough. That ultimately
peaked 40 months later in March 1980 with the CPI blasting up a
soul-crushing 14.8% YoY. Monthly-average gold prices skyrocketed a
colossal 322.4% higher during that span, literally more than
quadrupling! Yet again raging inflation fueled massive
investment demand for gold.
After effectively tripling and quadrupling during the only other
inflation super-spikes seen in this modern monetary era, does it
make sense for gold to languish flat to lower in this latest? Hell
no! While gold’s gains this time around probably won’t be as huge
with today’s far-larger aboveground gold supplies, a doubling isn’t
a stretch at all. Despite way more gold, the growth in global
fiat-currency supplies dwarfs that.
The
best estimates I’ve seen for total aboveground gold stockpiles peg
them near 75k metric tons back in 1970 and about 210k today. That’s
up 180% in five-plus decades, around a 2% compound annual growth
rate. During that same span the Fed’s broad M2 money-supply measure
has shot stratospheric from $590b to $21,347b, up about 3,500%!
That roughly 7.2% compound annual growth rate more than triples
gold’s.
And
that’s just US dollars. The Japanese yen, former pre-euro European
national currencies, and the euro saw similar if not larger
money-supply growth over this past half-century! So relative to the
endless supplies of fiat currencies spewed into the world, gold is
more precious today than during those last inflation super-spikes.
Once investors really start worrying about inflation, there’s not
much gold to go around.
So
far inflation’s corrosive and devastating impacts on investment
portfolios have been underestimated radically, but that will likely
start changing in 2023. The Fed’s uber-hawkish jawboning and
extreme rate hikes have convinced investors higher interest rates
will kill inflation. But the Fed is peddling snake oil, the
only way to stake this inflation super-spike is destroying the
lion’s share of that vast QE4 money printing.
When
even lowballed headline CPI inflation remains stubbornly high in
2023 despite 425 basis points of federal-funds-rate hikes in 9
months, investors’ faith in the Fed will be shaken. And
several factors will increasingly contribute to higher general
awareness of inflation’s ravages. These include ending artificial
suppression of gasoline prices, a lower US dollar boosting import
prices, and weaker corporate earnings.
Americans perceive inflation most in things we must buy often, led
by gasoline and groceries. The latest November CPI subindexes for
these surged 10.1% and 10.6% YoY. Gasoline prices would’ve been way
worse without the Biden Administration’s unprecedented artificial
suppression of prices ahead of 2022’s midterm elections. The
wartime US Strategic Petroleum Reserve was ordered to release 180m
barrels of oil!
That
temporary supply flood forced crude-oil and gasoline prices much
lower, considerably lessening Americans’ perceptions of inflation.
But that political stunt drained roughly 40% of the SPR, leaving it
at its lowest levels since the mid-1980s! Without that marginal
supply, oil and gasoline prices are heading back higher. That will
again ramp awareness and concern about this raging inflation among
investors.
And
as everyone feeding a family knows, food prices are soaring far
faster than the watered-down CPI suggests. Americans’ grocery
bills are probably up about 20% to 30% YoY, not just 10%. Some of
that is evident in the wholesale Producer Price Index, which isn’t
as politically-charged. Over this past year for example eggs,
vegetables, turkey, and pasta prices have soared 244.1%, 80.6%,
37.6%, and 32.8% YoY!
2022’s exceedingly-strong US dollar on those extreme Fed rate hikes
also really mitigated the impact of inflation. That higher
purchasing power relative to other major currencies made the vast
quantities of goods the US imports cheaper. But as the dollar
weakens in 2023, import prices will rise proportionally. Those
higher prices for a sizable fraction of overall US GDP will also
boost perceptions of raging inflation.
But
the dominant inflation concern for investors will be its
increasingly-dire impact on stock markets. That is what will ignite
massive gold investment demand for prudent portfolio
diversification! Persistently-rising general price levels really
erode corporate earnings. Companies are forced to pay more for
their inputs, but can’t pass along all those higher costs to
customers. They will eventually balk, risking lower revenues.
That
pinches profits, a serious problem when stock markets are really
overvalued. That’s certainly the case now, with the elite S&P 500
companies averaging trailing-twelve-month price-to-earnings ratios
of 28.5x entering December. That’s still in formal bubble
territory, which starts at 28x! And that’s despite the S&P 500
already being down 20.6% year-to-date. 2022’s young stock bear has
only just awakened.
The
US stock markets would still have to be cut in half to hit
their historical fair value of 14x earnings! The longer this bear
persists and the deeper it mauls stocks, the more investors will up
their tiny portfolio allocations in counter-moving gold. Those
remain effectively zero, as seen in the ratio between the value of
the leading and dominant US gold exchange-traded funds and the S&P
500’s overall market capitalization.
According to the World Gold Council, exiting Q3’22 GLD and IAU
accounted for 40% of all the gold held by all the world’s
physically-backed ETFs. That totaled 1,359 metric tons entering
December, which was worth $77b. Yet the elite S&P 500 stocks’
collective market cap then was $36,346b, implying American stock
investors had gold portfolio allocations on the order of 0.2%.
During an inflation super-spike no less!
If
those climb to 1% or 2% or maybe even 5% in coming years, gold
could easily double. Inflation slams stock markets, resulting
higher interest rates crush bond prices, and cash’s purchasing power
relentlessly erodes. Millennia of history have proven gold is the
refuge of choice during inflationary debasements of currencies.
Gold powers higher on balance on growing investment demand during
such dangerous times.
Gold
will start reflecting this raging inflation more in 2023 as the
scales fall from investors’ eyes. They will see high inflation
persisting despite 425 basis points of Fed rate hikes in 2022. They
will realize higher rates aren’t the inflation panacea Fed officials
claimed. With that blistering hiking cycle
already 85% done
relative to Fed officials’ terminal federal-funds-rate projections,
they’ll know the Fed is running out of ammunition.
Investors’ inflation worries will really ratchet up as corporate
earnings continue weakening, feeding this ravenous stock bear.
Higher gasoline prices and a lower US dollar will exacerbate
perceptions inflation is still raging out of control despite the
Fed’s extreme rate hikes. As their stock-heavy portfolios burn with
mounting losses, they’ll increasingly remember gold. Huge capital
will be reallocated into this inflation hedge.
Soaring gold investment demand will drive much-higher gold prices.
The biggest beneficiary will be gold-mining stocks. The leading GDX
gold-stock ETF is already up 37.4% at best since late September,
which amplified gold’s parallel 12.1% mean-reversion rally by 3.1x.
And the smaller fundamentally-superior mid-tier and junior miners we
specialize in well outperformed that. Their upside potential in
coming years is huge!
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The
bottom line is gold will increasingly reflect this latest inflation
super-spike in 2023. Gold investment demand will return with a
vengeance as 2022’s illusions are dispelled. As high inflation
persists, investors will realize extreme Fed rate hikes are
ineffective in slaying it. Confidence in the Fed will collapse as
it runs out of room to keep hiking. Investors will increasingly
worry inflation will rage much longer than they hoped.
That
will ravage corporate earnings, hammering still-overvalued stock
prices much lower. As this young bear deepens, investors will
increasingly seek to diversify their burning stock-heavy
portfolios. They will remember gold being the ultimate inflation
hedge, and start shifting capital into it. With gold allocations
now effectively zero, there’s vast buying coming which will fuel
powerful bull runs in gold and its miners’ stocks. |