Gold’s Turn to Shine


Gold’s Turn to Shine

Adam Hamilton    
December 31,
2021     2748 Words

 


Gold’s turn to shine again is nearing, with major bullish drivers
aligning heading into this new year.  The Fed’s vast deluge of new
money remains intact despite QE tapering, continuing to fuel raging
inflation.  A new rate-hike cycle to fight that is looming, but gold
has thrived during past cycles.  This Fed tightening will weigh
heavily on QE-levitated bubble-valued stock markets.  As they fall,
gold investment demand will surge.

 

Gold
mostly spent 2021 grinding sideways-to-lower in a high
consolidation.  That lack of upside progress left this leading
alternative asset increasingly out of favor with speculators and
investors alike as the year marched on.  Heading into year-end
midweek, gold was down 4.9% year-to-date.  While
psychologically-grating, maybe big gains needed to be digested after
gold surged 18.4% in 2019 then another 25.1% in 2020.

 


After two massive 42.7% and 40.0% gold-bull uplegs crested in 2020
alone, the next one began gathering steam in early 2021.  Over
several months into early June, gold powered 13.5% higher in a solid
young upleg.  But unfortunately that was prematurely killed by
gold-futures speculators’ supremely-irrational fears of Fed
tightening
.  Hawkish FOMC meetings and economic data spawned
serious bouts of selling.

 

Over
the past half-year, Fed-hawkish catalysts ignited several
heavy-to-extreme gold-futures pukings slamming gold.  I analyzed
them all a couple weeks ago in an essay about
gold weathering
this hawkish Fed
.  Those periodic big gold-futures selloffs
really damaged sentiment
, leaving
investors
apathetic about gold
.  They won’t migrate back in with their
vast pools of capital before gold upside momentum attracts them.

 

With
leveraged gold-futures speculators periodically fleeing in terror
and investors missing in action, gold couldn’t make any significant
headway.  But with traders finally coming to accept the Fed’s new
tightening paradigm, gold’s vexing drift should be ending.  As
speculators and investors return, gold’s interrupted bull upleg
should resume with a vengeance.  Several major bullish factors are
aligning to supercharge demand.

 

All
three are inseparably intertwined with the Fed, starting with its
epic money printing
.  This central bank birthed its fourth
quantitative-easing campaign way back in October 2019.  It was
radically expanded in March 2020 during the pandemic-lockdown stock
panic, which Fed officials feared would trigger a full-on depression
due to the negative wealth effect.  So they redlined the Fed’s
monetary printing presses to crazy extremes.

 

The
Fed monetized a wildly-unprecedented $4,632b in bonds in the short
21.9 months since then!  All that new money conjured out of thin air
to inject into the US economy catapulted the Fed’s balance sheet a
terrifying 111.4% higher!  This profligate central bank has
essentially more than doubled the monetary base in about a
year-and-a-half!  That epic deluge of new dollars directly fueled
the raging price inflation since.

 

When
money supplies grow faster than the goods and services on which to
spend them, inflation is the result.  Relatively-more money
competes for and bids up the prices on relatively-less everything
else.  Fed officials constantly try to downplay this ironclad
historical relationship, deflecting and obscuring by claiming
supply-chain problems are driving this devastating inflation.  They
don’t want to accept their just blame.

 


Those many trillions of new dollars the Fed force-fed into the
economy artificially boosted demand for goods and services,
directly driving the snarled supply chains.  Way back in 1963,
legendary American economist Milton Friedman warned “Inflation is
always and everywhere a monetary phenomenon.”  Price levels don’t
universally and persistently rise unless excessive money-supply
growth is bidding them higher.

 

Gold
has always been the ultimate inflation hedge because its
above-ground supply growth is naturally-constrained.  Global gold
mined supply only adds on the order of 1% per year, far behind
leading fiat currencies’ double-digit inflation rates.  All that new
money ultimately competes for limited gold, driving up its price
until a new proportionally-higher equilibrium is reached.  That
guarantees far-higher gold prices ahead.

 

This
chart superimposes gold over the Fed’s balance sheet during the last
several years.  Monetary growth rocketed stratospheric after March
2020’s stock panic, and has remained very high ever since
Gold’s huge 40.0% upleg in mid-2020 reflected that flood of
freshly-evoked US dollars, but in 2021 gold fell way behind.  Gold
needs to power much higher in coming years to reach equilibrium with
this flood of money.

 


 


Through all 26.5 months of QE4, the Fed’s balance sheet has
mushroomed a shocking 122.5% higher or $4,841b!  Gold needs to soar
dramatically higher to reflect this crazy new world with an $8.8t
Fed balance sheet
.  In the year before QE4 was born, the balance
sheet averaged just $3.9t.  So the Fed’s effective monetary base
underlying the US-dollar supply is now 2.2x higher.  That’s
super-bullish for gold going forward.

 


During that same pre-QE4-year, gold averaged $1,337.  To rise
proportionally with that colossal flood of new money, gold would
have to soar up near $2,980!  That’s a heck of a lot higher from
recent prevailing $1,800ish levels.  And don’t tell gold-futures
speculators, but tapering is not tightening.  This recently-doubled
QE4 tapering just slows the pace of monetary growth, it
doesn’t unwind a single dollar of QE4.

 

When
the Fed buys bonds with QE, that money is literally created from
nothing on purchase.  The bonds move to the Fed’s balance sheet,
while that new money paid is transferred to the bond issuer.  In
QE4’s case, 2/3rds of that new money was used to monetize US
Treasuries.  The US government immediately spent that $3,528b,
injecting that money into the US economy which fueled the raging
price inflation
today.

 


Slowing and stopping QE bond buying leaves all that new money still
sloshing around the economy.  QE can only be reversed through
quantitative tightening
, which means the Fed actually sells the
bonds that it previously bought.  The money paid to the Fed is
destroyed, reducing its balance sheet and the monetary base.  This
Fed won’t risk unwinding its trillions of dollars of QE4 through QT,
as that would crash the stock markets.

 


Several years after QE3 bond monetizations ended, the Fed tried QT
starting in Q4’17.  The FOMC had $3.6t of new QE money to reverse,
and gradually accelerated QT over the following year.  But QT is the
death knell for
QE-levitated
stock markets.  Mostly in Q4’18 when
QT hit full-speed,
the flagship S&P 500 stock index collapsed 19.8%!  Unable to stomach
a healthy rebalancing bear market, the Fed capitulated.

 

It
soon started slowing QT, which was fully stopped years ahead of
schedule by September 2019.  Then just a month later, the Fed spun
up QE4.  QE3’s prematurely-truncated QT only added up to $825b,
less than a quarter
of the $3,618b of QE the Fed should’ve
unwound.  The Fed won’t risk collapsing the stock markets by trying
QT again.  So that colossal $5.0t of freshly-conjured QE4 money will
stay in the economy.

 

Way
too scared to start unwinding QE4 through QT, Fed officials are
instead telegraphing tightening by hiking rates while the Fed’s
mammoth balance sheet remains intact.  At mid-December’s
uber-hawkish FOMC
meeting
, individual Fed officials’ federal-funds-rate
projections soared dramatically higher.  They went from expecting
barely one rate hike in 2022 three months earlier to forecasting
fully three
starting next spring.

 

And
those three in 2022 are followed by three more in 2023, making for a
full-on rate-hike cycle!  Fed officials are finally worried
enough to start fighting this rampaging inflation beast their
extreme money printing unleashed.  So gold more-than-likely faces a
new rate-hike cycle over the next couple years or so.  But this
cowardly Fed will halt rate hikes fast if the stock markets fall far
enough, probably near 20% like during QT.

 


Traders often assume Fed rate hikes are bearish for gold, primarily
because they tend to boost the US dollar which gold-futures
speculators often trade in lockstep opposition of.  But historically
gold has fared really well during Fed-rate-hike cycles.  The
last one ran from December 2015 to December 2018, when the Fed hiked
its federal-funds rate
nine consecutive
times
for 225 basis points total!  Yet gold climbed anyway.

 

Over
that exact span it rallied 17.0% higher.  Some years ago I did a
research project analyzing how gold performed through all rate-hike
cycles since 1971.  There were 11 preceding this latest one, which
was the 12th.  During the exact spans of all 11 earlier ones, gold
averaged great 26.9% absolute gains!  But the majority 6 of those 11
where gold climbed were far better, with gold averaging

huge gains of 61.0% each!

 


While gold did fall during the remaining 5, its average losses were
asymmetrically way smaller running just 13.9%.  I last updated that
research thread in a March 2017 essay, analyzing
gold’s
performance during Fed-rate-hike cycles
in depth.  That depended
on two key factors, how gold is priced leading into rate-hike cycles
and how fast the Fed tightens.  Gold entering relatively-low and
gradual hikes are the most-bullish.

 

This
coming 13th Fed-rate-hike cycle of the modern era should tick both
boxes.  Gold remains relatively-low compared to its August 2020 peak
of $2,062, and is far from overbought after mostly grinding
sideways-to-lower ever since.  The FOMC is scared of being blamed
for tanking these fragile stock markets, so it won’t hike fast
Fast means individual hikes over a quarter-point, or acting between
normal FOMC meetings.

 

At
worst these coming rate hikes will hit at a fairly-slow
once-per-FOMC-meeting cadence.  And they will exclusively be the
smaller quarter-point increases in the federal-funds rate. 
Quarter-point hikes done at consecutive FOMC meetings aren’t a
problem for gold.  That last late-2015-to-late-2018 rate-hike cycle
saw streaks of three and later five consecutive rate hikes, yet gold
still had no problem rallying on balance.

 

Fed
rate hikes are generally bullish for gold because they are
bearish for stock markets
.  As stocks roll over on Fed
tightening, gold investment demand surges for prudent portfolio
diversification.  Gold usually rallies on balance during material
stock-market selloffs, making it an essential counter-moving
portfolio stabilizer.  And these lofty stock markets are in a world
of hurt when the FOMC finally starts hiking rates again.

 

That
gargantuan $5.0t of money printing during QE4 enormously boosted the
stock markets.  At best in late December, the S&P 500 had
skyrocketed 114.2% since March 2020’s stock panic.  It is certainly
no coincidence those massive gains nearly exactly mirrored
the Fed’s 111.4% balance-sheet ballooning during that timeframe! 
The stock markets depend on the excess liquidity spawned by
Fed-balance-sheet expansion.

 


Because the S&P 500 was rapidly catapulted higher on the Fed’s
monetary largesse, corporate earnings didn’t have the chance to
catch up with lofty stock prices.  Entering December, the 500 elite
stocks in that leading benchmark averaged trailing-twelve-month
price-to-earnings ratios way up at 32.7x!  That is well into
bubble territory, which starts at 28x historically.  It is twice the
century-and-a-half average fair-value at 14x.

 


Dangerously-high
bubble valuations
in record-high stock markets are
exceedingly-risky
entering a Fed-hiking cycle!  Even though the
Fed’s balance sheet won’t be shrinking through QT, higher prevailing
rates squeeze both earnings and multiples investors are willing to
pay.  Corporations are deep in debt after the Fed ran a
zero-interest-rate policy for seven years before that last hiking
cycle then again since March 2020.

 


Higher federal-funds rates drive the interest carrying costs of debt
higher, eroding profits.  That in turn forces valuations even
deeper into bubble territory
.  And with that $5.0t of QE4 money
printing remaining in the economy even after this turbo taper ends,
serious inflation will persist.  That is even more damaging to
overall corporate earnings, as it shrinks them universally
regardless of debt loads companies are carrying.

 


Rising general price levels force input costs higher, leaving
corporations with two bad choices.  They can eat higher costs, which
directly cuts into their bottom-line profits.  Or they can attempt
to raise their selling prices to pass along their higher costs.  But
customers can balk at price hikes, choosing to buy less or looking
elsewhere for suitable substitutes.  That results in lower sales
which are amplified by lower earnings.

 

So
these already-bubble-valued stock markets face fierce fundamental
headwinds from Fed rate hikes and the terrible inflation unleashed
by the Fed more than doubling its balance sheet.  That means a major
S&P 500 correction approaching 20% or a long-overdue bear market
exceeding that is highly-probable during the Fed’s next rate-hike
cycle
.  Weaker stock markets fuel much-stronger gold investment
demand.

 


Every investment portfolio should have some gold exposure for
diversification.  For many centuries if not millennia, the minimum
recommended allocation to gold has been 5% to 10%.  Given stock
markets’ risky outlook, 20% would probably be more prudent today. 
But thanks to the hyper-complacency driven by the Fed’s huge QE4
stock-market levitation, American stock investors’ collective gold
allocations are close to zero.

 


Entering December, the combined holdings of the leading and dominant
GLD SPDR Gold Shares and IAU iShares Gold Trust gold exchange-traded
funds were worth $85.4b.  That was just 0.2% of the collective
$41,932.8b market capitalizations of all S&P 500 stocks!  This proxy
reveals radical underinvestment in gold.  If the coming
market turmoil even pushes that to 2.0%, gold would soar on those
huge capital inflows.

 

When
stocks seemingly do nothing but rally forever on endless Fed money
printing, investors don’t care about prudent portfolio
diversification.  But when stocks start falling significantly,
investors seek safe-haven alternative assets led by counter-moving
gold.  And interestingly the odds of stock markets falling sharply
in coming months are surging.  Traders are going to test the Fed
to see how much selling it can bear!

 

Fed
officials are always worried major stock-market selloffs will slow
consumer spending enough to drive recessions or even depressions. 
As stock prices fall, people feel poorer and pull in their horns. 
That cuts into corporate sales and profits, eventually forcing
layoffs and exacerbating that downward spiral.  So the Fed has a
long history of halting tightening once stocks fall far enough
to risk a cascading negative wealth effect.

 

Over
this past decade, the Fed has stepped in to stabilize stock markets
once they sold off between 10% to 15%.  That included both jawboning
about easing and actually changing policies to be easier.  The March
2020 stock panic where the S&P 500 plummeted 33.9% in less than five
weeks scared the Fed so much it launched QE4, the biggest
money-printing binge
in world history!  The so-called “Fed put”
is alive and well.

 


Sizable stock-market selling is likely in coming months until Fed
officials abandon tightening, revealing the strike price in
SPX-drawdown terms for the Fed Put.  That could mean pausing the QE4
turbo taper, delaying the imminent rate-hike cycle, putting it on
hold if it is already underway, or maybe even ramping back up QE4
bond monetizations.  Any of these easings will hammer the US dollar,
fueling massive gold buying.

 

The
biggest beneficiaries of much-higher gold prices ahead are the
fundamentally-superior
mid-tier and
junior gold stocks
.  They rallied sharply with gold into
mid-November, but were dragged back down to their stop losses by a
bout of heavy gold-futures selling.  Our stoppings averaged out to
neutral, fully recovering our capital.  So we’ve been aggressively
redeploying buying back in low in our weekly newsletter.

 

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The
bottom line is gold’s turn to shine is coming.  This leading
alternative asset’s secular bull is set to resume with a vengeance
in 2022 and beyond.  The Fed is leaving all the many trillions of
new dollars it conjured up during QE4 in the economy, where they
will continue to bid up prices driving raging inflation.  Gold will
ultimately rise proportionally to reflect a more-than-doubled money
supply, climbing to way-higher prices.

 


Fed-rate-hike cycles are no threat to gold either, as it has
averaged strong gains through all dozen during modern times.  Rising
rates really damage stock markets, where persistent weakness fuels
strong gold investment demand.  And stock-market downside risks are
serious with these bubble valuations driven by all that QE4 money
printing.  This is a fantastic environment for gold to return to
favor as the best portfolio diversifier!

 

Adam Hamilton,
CPA
    

December 31,
2021    
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