Thursday saw gold take its biggest one-day dive of 2017. Gold stocks got kicked in the teeth, with the benchmark gold miners’ ETF (GDX) slammed down nearly 5%. Did we say kicked in the teeth? It was like getting dental work with a ball-peen hammer!
Considering that gold and silver miners rallied big time across the board on Wednesday, investors must have felt that beating personally.
I don’t see immediate cause for worry, though. It may just be the market gods laughing as they set up the next rally.
The markets love to make fools of investors all the time. There’s an old saying, “The best-laid plans of mice and men often go awry.” That goes double for precious metals investors.
Don’t worry. The next rally is going to be sweeter.
Now the reasons for the sell-off are obvious. Fed Chair Janet Yellen was a longtime interest-rate dove. But two weeks ago, she bit the head off that dove … put on her contrary pants and her sideways hat … and suddenly got all gangster-sounding about raising interest rates.
That was the first smackdown for gold miners. They recovered. But then this week, three other Fed members showed themselves as inflation hawks. Governors Lael Brianard, John Williams and William Dudley stomped all over the dovish banner they had carried for years.
Dudley in particular is seen as a close ally of Yellen. And he said the case for tightening monetary policy “has become a lot more compelling.”
So, what are these guys talking about?
Well, the Fed’s favorite inflation gauge is something called the PCE Price Index. On Wednesday, the latest data showed the headline PCE Price Index rose 1.9% year-over-year. That’s the highest level since February 2013.
Even backing out volatile food and energy, the core reading was still the highest since January 2015.
As the gangsters say: “Day-y-yum!”
Meanwhile, the February ISM Manufacturing PMI is also running hot. That’s a gauge of the price producers are paying. It came in at 57.7, blowing away expectations. Any reading over 50 indicates expansion. This is expanding like a bicycle tire hooked up to a truck tire pump.
And it’s not just the U.S. The Eurozone manufacturing PMI has hit a 70-month high. And global manufacturing PMI hit a 69-month high.
So, you can see that it’s likely the Fed will raise interest rates sooner rather than later.
Higher interest rates are perceived as bearish for gold. That’s because bonds pay interest and gold doesn’t.
Finally, let’s add in the fact that President Trump convinced Congress and investors this week that he’ll show more focus going forward. That means an end to Obamacare followed by big tax cuts.
That gets the market excited. It also should be inflationary.
Now let us tell you why the view that higher interest rates are bad for gold is all wet. And why the pullback in miners is a buying opportunity.
It is, in fact, why the gold gods are laughing.
First, we know that President Trump believes that other countries are unfairly manipulating their currencies lower. He, in fact, wants a weaker greenback.
But let’s say that other forces in Washington force Trump’s hand and make the dollar stronger. And the way they do that is primarily by raising interest rates.
The big question is, will they raise interest rates fast enough to keep up with inflation?
Look at Citi’s “Inflation Surprise Index.” This shows how inflation surprises are running around the world.
You can see that inflation is running way ahead of expectations. The last time this happened was in 2007. And that time … gold rose by 68%!
Why did that happen? First, because interest-rate hikes are slow to keep up with actual inflation. In fact, the U.S. is close to real negative interest rates right now, because consumer inflation is running at 2.5%.
Second, gold is a hedge against inflation. It has certainly worked that way in Europe. Their currency, the euro, has been under pressure for months. So, gold is hitting new highs in terms of euros.
Don’t you think Europeans who used euros to buy gold in December are thanking their lucky stars right now? Heck, yeah!
Meanwhile, here in the U.S., the greenback has gained ground recently, at gold’s expense. But the dollar is still below where it started 2017.
The dollar is rallying on expectations of tax cuts and interest-rate hikes. But how much of that is priced in? We’d say a lot.
So, sure, gold miners are spitting broken teeth all over the sidewalk. Thuggish Fed members are talking smack about raising rates. It’s likely too little, too late.
Gold is going to pick itself up off the cement and ride that inflation wave to new highs. And the gold gods will get the last laugh.