Look Beyond the CPI Headline Data

Despite slightly disturbing new inflation data released during the week, equity markets saw a strong recovery.  This was partially reversed a day later, but the overall trend still remained upward and continued so initially at the start of the current week.  Conversely, the gold price fell back quite sharply, even testing the year’s lows at around the low $1,640s in U.S. dollar terms as the dollar index again showed gains against other global currencies.  The gold price has seen something of a recovery in European trade at the start of the current week and as I write, is back in the $1,660s, but whether it can hold on or increase further once US markets get fully under way this week remains to be seen.

Gold is thus seeing some respite today from a weaker US dollar.  Dollar strength had been negative for the gold price at the end of last week, raising interest rates which had made non-interest generating gold less competitive as an investment asset.  US Treasury rates had risen to 4%, for example, which is strongly negative for gold.

I had commented here in previous articles that one should keep a wary eye on the Chicago Mercantile Exchange’s Fedwatch Tool readings as these give a good idea as to how the market professionals view the likely US Federal Reserve’s interest rate raising plans at forthcoming Federal Open Market Committee (FOMC) meetings.  The next such takes place at the beginning of November and this guide had already been predicting a 75 basis point (3/4%) increase in the Federal Funds interest rate would be imposed by around odds of 75:25.  

But following Thursday’s Consumer Price Index (CPI) report from the Bureau of Labor Statistics, which flagged some additional inflationary warning signals, the Fedwatch Tool moved almost 100% in favor of the 75 basis point increase at the November FOMC meeting.  And what should perhaps have been even more worrying for the markets it was also suggesting a similarly sized increase again at the December meeting bringing the year-end Federal Funds rate to between 4.5 and 4.75%.  Given that this rate was at 0-0.25% back at the beginning of the year that represents a huge and rapid rate rise and signifies that the Fed sees that instigating – or maybe confirming – the move into an economic recession, which such a rate increase would surely lead to if we are not already there, is one of its prime tools in its fight to conquer inflation.  Looking even further ahead, many forecasters are even predicting a 4.75-5% Federal Funds interest rate by the end of Q1 2023.

Returning to Thursday’s CPI data, the headline figure actually showed that year to date inflation was marginally lower than that announced a month earlier. This seems to have led some to feel that it may have peaked, perhaps prompting the apparently euphoric reaction in the equities markets.  Writing here a week ago we warned that this might be the case, but that it would be the core inflation rate (which strips out the more volatile food and energy costs) which should be viewed much more carefully.  This indeed did rise quite significantly month-on-month which will have been largely responsible for the Fedwatch Tool reaction and will likely be far more relevant to the forthcoming FOMC deliberations.  Thus inflation still appears to be rising and therefore remains a huge problem in the Fed’s stated intentions of bringing the level down to 2% - which I have stated that I don’t think is achievable in the short to medium term in any case.

There are also worries, though, that the Fed may be paying too much attention to the long term damage that inflation may be doing to the US economy.  Conversely it is perhaps not paying enough to the potentially debilitating effects of economic recession and the strong dollar’s impact on the competitiveness of US exports in global markets.

As for gold and gold stocks, the yellow metal has fallen by around 10% in price since the beginning of the year – not a particularly good performance for an asset which is supposedly a wealth protector.  The consolation for the gold holder, perhaps, is that its fall in value has not been nearly as severe as in equities or especially in bitcoin, and in my opinion it still has a good chance of price recovery in the short to medium term, while equities and bitcoin will likely fall back further as recession bites and/or inflation continues to be a factor, although they appear to be bucking the trend at the moment.

Gold stocks have fallen even more than bullion in percentage terms -   unjustifiably so in many cases in my opinion.  Even at current gold prices the major gold producers will be making decent profits as margins remain strong.  Some major producing nations, like Australia, where the domestic currency has been weakening against the US dollar, are seeing record gold prices in their domestic currencies in which their primary costs are incurred and many of the gold majors are heavily involved in producing gold in these nations.  True, costs will play catch-up, but this will take time and profits will benefit accordingly in the meantime.  Do your due diligence if gold stock investment is in your plans.  It’s an ill wind that blows nobody any good!