By Adam Hamilton
Gold has behaved strangely over this past year, largely ignoring the biggest inflation super-spike since the 1970s. The Fed’s extreme rate hikes were to blame, spawning epic anomalous market distortions. With that blistering rate-hike cycle nearing its end, the Fed’s gold anomaly is unwinding. That is freeing the yellow metal to soar to reflect this raging inflation driven by the Fed’s mind-boggling money printing.
Inflation is out of control, with the monthly headline CPI reads averaging shocking 8.0% year-over-year surges in 2022. At its peak last June, that metric hit a miserable 40.6-year high up 9.1%! Nothing like that had been witnessed since the 1970s, even though today’s watered-down CPI seriously understates inflation compared to the 1970s version. The Fed is directly responsible for these crushing price surges.
Fed officials panicked during March 2020’s pandemic-lockdown stock panic, fearing a depression. So they redlined their monetary printing presses to dizzying speeds. Over the next 25.5 months into mid-April 2022, the Fed’s balance sheet which is effectively the monetary base skyrocketed up an absurd 115.6% or $4,807b! The US central bank more than doubled its global US dollar supply in just a couple years!
That extreme monetary growth radically outpaced that in the underlying economy. Relatively-way-more US dollars are competing for and bidding up the prices on relatively-less goods and services. That kind of inflation-super-spike environment is wildly bullish for gold, which thrives since its own aboveground supply growth is greatly limited by natural mining constraints. Gold’s performance during the 1970s proved this.
That decade saw two inflation super-spikes, peaking with the CPI surging 12.3% and 14.8% YoY. The first ran 30 months into December 1974, during which monthly-average gold prices from trough to peak CPI months soared 196.6% higher! In the second bigger 40-month one peaking in March 1980, gold in those same terms skyrocketed 322.4%! That’s nearly tripling and more than quadrupling in inflation super-spikes!
Yet in 2022 during the third inflation super-spike of this modern monetary era, gold somehow slumped 0.3%. There was nothing wrong with gold’s fundamentals, as the World Gold Council’s latest Q4’22 Gold Demand Trends report just published this week reveals. Global gold mined only grew 1.2% YoY in 2022, while overall world demand climbed 1.5%. Investment demand enjoyed sizable 10.5% growth over 2021.
And central banks are flooding into gold like it’s going out of style. Their 2022 demand soared 152.3% YoY, hitting its highest levels since 1967! There is no way gold should’ve been flat with that kind of year. Even worse in 2022, between early March to late September gold cratered a brutal 20.9% while inflation raged. Gold’s bearish price action last year was exceedingly anomalous, thanks to extreme Fed distortions.
This week the Fed executed its eighth consecutive federal-funds-rate hike in as many FOMC meetings. While only 25 basis points following six larger 50bp and 75bp ones in a row, it drove the FFR up to a 4.50%-to-4.75% target range. That makes for a 4.63% midpoint, which is merely 50bp under top Fed officials’ latest terminal FFR projection of 5.13% for year-end 2023. This Fed rate-hike cycle is almost over!
After hiking a colossal 450bp in just 10.6 months, the Fed’s own projections imply just 50bp left at most. That means 9/10ths of this extreme hiking is finished, along with all those bigger hikes! Despite inflation still running red-hot, the Fed can’t force rates higher indefinitely without sinking the entire heavily-indebted US economy. The federal government’s debt alone is $31,529b, requiring $1,576b of annual interest at 5.0%!
With the specter of more colossal hiking waning, gold has already powered dramatically higher out of late September’s deep stock-panic-grade lows. As of midweek following this latest FOMC decision, gold’s young upleg has soared 20.2% higher in 4.2 months! That left the yellow metal at $1,951, right back near mid-April-2022 levels before the Fed’s most-extreme tightening ever gathered steam. Gold is off to the races.
This chart overlays recent years’ Fed policy decisions on gold and the benchmark US Dollar Index. Gold price action is usually dominated by hyper-leveraged gold-futures speculators. They look to the fortunes of the US dollar as their main trading cue, doing the opposite and bullying gold prices around. Both Fed rate cuts and hikes, and quantitative-easing money printing and quantitative-tightening bond selling are noted.
Before Fed officials panicked last year, gold was faring well. Year-to-date in early March, it had rallied a strong 12.1% although part of that was a geopolitical spike on Russia invading Ukraine. It’s important to realize gold had been powering higher on balance even though the dollar was also climbing. That gold upleg surged 18.9% over 5.3 months despite a parallel 4.9% USDX rally. Normal dollar moves are no problem.
The Fed birthed this latest rate-hike cycle innocuously in mid-March with a maiden 25bp hike, ending the zero-interest-rate policy in place since March 2020’s stock panic. Top Fed officials were forecasting their federal-funds rate exiting 2022 near 1.88%. That implied six more 25bp hikes at last year’s six remaining FOMC meetings. That normal pace didn’t distort markets, gold rallied 0.3% in the week after that Fed decision.
But something snapped in mid-April when the latest CPI soared 8.5% YoY. Top Fed officials started to sweat bullets, taking every opportunity to jawbone aggressively about faster rate hikes. So the US dollar began to surge on coming bigger yield differentials over other major currencies, unleashing withering gold-futures selling. Between the days before that CPI report and early-May FOMC meeting, gold plunged 4.5%.
The USDX blasting up 3.5% in that short span was the culprit. The FOMC hiked by 50bp right after, the biggest FFR increase it had dared since May 2000. Fed chair Jerome Powell warned at his usual post-meeting press conference that more big hikes were likely coming, saying “there’s a broad sense on the Committee that additional 50-basis-point increases should be on the table for the next couple of meetings.”
During the week starting with that Fed day, the USDX climbed another 0.4% while gold fell another 1.5%. Interestingly Powell had also advised “a 75-basis-point increase is not something the Committee is actively considering.” But CPI inflation stayed hot, with the print released in mid-May still running up 8.3% YoY. So at their next FOMC meeting in mid-June, Fed officials embarked on a stunning shock-and-awe campaign.
Just a few trading days after another monthly CPI read hit 8.6% inflation, the Fed unleashed a monster 75bp FFR hike! This was its largest since way back in November 1994. Meanwhile top Fed officials’ year-end-2022 FFR outlook nearly doubled from 1.88% to 3.38%. That would require another 175bp of hiking on top of the 150bp just done, necessitating bigger FFR hikes with only four FOMC meetings left in 2022.
Over the next month, the USDX blasted another 3.0% higher which helped hammer gold another 5.4% lower on relentless gold-futures selling. While other major central banks with competing currencies were starting to hike their own rates, they were way behind the Fed. Currency traders figured that made the US dollar much more attractive to global investors. Never mind inflation eroding the dollar’s purchasing power!
As major currencies usually meander with all the fury of a glacier, the USDX was shooting parabolic in an exceedingly-anomalous spike thanks to those big Fed rate hikes. And the FOMC continued them at its next meeting in late July, catapulting the FFR another 75bp higher. It had hiked 225bp off zero in just 4.4 months, a blistering rate-hike cycle! That day the Fed chair actually said the FFR was “now … at neutral”.
He also declared in his presser, “We’ve been front-end loading these very large rate increases, and now we’re getting closer to where we need to be.” So the implied end of massive rate hikes was a big dovish shift really helping gold. Over the next couple weeks or so it rebounded 4.4% as the USDX dropped 1.4%. Again gold has no trouble handling normal Fed-rate-hike cycles, as I’ve researched historically in depth.
In mid-February 2022 before the Fed went off the reservation with extreme rate hikes, we published an essay on gold thriving in rate-hike cycles. There were a dozen since 1971 before this current one, in which gold averaged great 29.2% gains! Gold fared best when it entered them relatively low and they were gradual, no more than one 25bp hike per regularly-scheduled FOMC meeting. This cycle is anything but!
Gold mostly consolidated after that second monster 75bp hike into late August, when Powell spoke again at the Fed’s Jackson Hole symposium. He warned then that slaying inflation would require a “lengthy period of very restrictive monetary policy” that “will also bring some pain to households and businesses”. That staked Wall Street’s popular Fed-dovish-pivot narrative, unleashing still more heavy gold-futures selling.
Yet Fed officials’ oft-stated premise that higher rates for longer will reverse inflation is problematic. From December 2008 to December 2015, the Fed kept ZIRP in place continuously for 7.0 years. The FFR target averaged 0.13%, yet monthly headline CPI inflation just averaged 1.4% YoY increases during that secular span! If low rates don’t spawn inflation, higher rates won’t dispel it. Excessive money fuels inflation.
Over the next several weeks gold plunged another 5.3% as the USDX shot up another 1.2%. Those moves were further exacerbated by the next late-September FOMC meeting, where the FOMC executed its third monster 75bp hike in a row! After 300bp since mid-March, the FFR hadn’t soared faster in any 6-month span since March 1981. But that hiking cycle hadn’t started off zero, so it was much less extreme.
Over the subsequent week starting that Fed day, the USDX soared another 3.6% to a stunning 20.4-year secular high! In just 6.0 months it had skyrocketed an exceedingly-anomalous 16.7% higher, leaving it extraordinarily overbought. Herd sentiment was crazy-bullish, and such extremes are never sustainable for long. Gold dropped another 2.2% in that span, extending its own parallel plummeting to 20.9% in 6.6 months.
That left gold way down at $1,623, an extreme 2.5-year low not seen since just emerging from March 2020’s brutal pandemic-lockdown stock panic! One trading day before gold bottomed, we published an essay looking at the parallel false gold-stock panic. Right then in the throes of peak gold bearishness, gold was considered doomed to spiral lower indefinitely. But I took a contrarian bent arguing for a big rally…
“Gold-futures speculators fled unleashing enormous selling as the US dollar soared parabolic on the Fed’s most-extreme hawkish pivot ever. That tainted gold psychology, leaving investors bearish enough to join in the selling. But all that has mostly been spent, with speculators’ gold-futures positioning and investors’ gold-ETF holdings at major multi-year lows. As all that reverses, gold will soar launching gold stocks way higher.”
With those gold-futures speculators exhausting their probable selling firepower, gold was due to bounce sharply igniting a major mean-reversion upleg. That indeed soon got underway, as in just over a week out of that deep late-September low gold rocketed 6.3% higher! Gold-futures short-covering buying flared on the lofty US Dollar Index rolling over hard with a big 3.4% loss. But the Fed wasn’t done with big hikes.
In early October, Fed officials started leaking to the Wall Street Journal’s famed Fed-whisperer reporter that they wanted to do another 75bp at the next FOMC meeting in early November. During the rest of October, Fed officials increasingly jawboned for more big hikes. And they indeed did their fourth monster 75bp hike in a row in early November! That pummeled gold back down to within spitting distance of its low.
That looked like a major double-bottom, and gold-futures speculators’ likely selling firepower was once again expended. So I argued that very week that the Fed’s dollar/gold shock was ending in another contrarian essay. Still fighting the herd which is always wrong at extremes I concluded then, “After hiking an astounding 375 basis points in just six FOMC meetings, Fed officials are running out of room to keep going.”
“Their federal-funds rate is nearing terminal-level projections, leaving little room for more hawkish surprises. Without those to keep goosing the parabolic US dollar, it is overdue to roll over hard in massive mean-reversion selling. That weaker dollar will fuel huge normalization buying in gold futures, which have been driven to bearish extremes. Gold will power higher as inflation continues to rage…”
All that indeed proved spot-on true! Over the next couple weeks starting with that early-November Fed day, gold soared 8.0% while the USDX cratered 4.5%. These competing currencies were fiercely mean reverting out of last year’s extreme Fed anomalies. Once underway, such moves take on lives of their own as traders increasingly pile on to chase momentum. Another big Fed rate hike in mid-December was ignored.
Then the FOMC ended its four-long streak of 75bp monsters with a still-large 50bp hike. More interestingly, top Fed officials’ projections for year-end-2023 FFR levels climbed a more-hawkish-than-expected 50bp to a 5.13% midpoint. That only implied another 75bp of hiking after 425bp in 9 months. And that dot-plot FFR outlook is notoriously unreliable, as the Fed chair himself has warned during press conferences.
Just a year earlier in mid-December 2021, these same elite Fed guys were projecting an FFR near 0.88% exiting 2022! Yet because they panicked about inflation not even spawned by low rates but extreme money printing, the FFR actually ended 2022 at 4.38%. Gold continued rallying on balance while the USDX kept falling into this week’s FOMC meeting. Again the Fed just hiked by 25bp, its smallest since March.
Fittingly gold hit a new upleg high of $1,951 that very day, as the US Dollar Index fell to a new downleg low of 101.2. That extended their total mean-reversion moves since late September to 20.2% gold gains and an 11.4% USDX loss. With 450bp of federal-funds-rate hiking done in just eight FOMC meetings, and only 50bp left until terminal levels, the Fed’s ability to shock markets is finished so distortions are reversing!
Gold is finally being freed from its extreme-Fed-rate-hike-cycle shackles to start reflecting this underlying raging inflation. It might not triple or quadruple again like during those 1970s inflation super-spikes, but a doubling seems quite doable given the Fed’s balance sheet is still 103.7% larger today than before March 2020’s stock panic! Yes the FOMC is also shrinking its balance sheet through QT, but that’s really slow.
Fed officials are terrified of monetary destruction spooking markets, so they don’t talk about it much. This QT2 campaign was supposed to ramp to terminal levels of $95b per month of monetized bond selling in September. Yet as of late January, it has only averaged $74b monthly in that span. At that pace, it would take another 59 months to fully unwind that extreme post-panic money printing or 29 months to reverse half!
That’s a long time for grotesquely-bloated US-dollar supplies to keep fueling red-hot price inflation. And the USDX never surged last year on the Fed dumping Treasuries, it was always on those big-and-fast FFR hikes. With the FOMC nearly out of room in this extreme hiking cycle, more big hikes are really unlikely. Even today’s 4.63% FFR will increasingly risk bankrupting the heavily-indebted US government.
So the Fed’s gold anomaly is unwinding, unchaining the yellow metal to properly reflect a doubled US-dollar supply since March 2020. And the resulting gold buying is only starting, as I analyzed in another popular essay several weeks ago. Gold-futures speculators still have vast buying left to do to drive this young upleg much higher. And the larger identifiable investment buying has barely even started, which is super-bullish.
The biggest beneficiaries will be its miners’ stocks, which really amplify gold’s gains due to their earnings leverage to its prices. As of midweek, the leading GDX gold-stock ETF has blasted 52.1% higher at best during gold’s parallel 20.2% upleg. That makes for good 2.6x upside leverage to gold, right in the middle of GDX’s usual 2x-to-3x range. The bigger gold’s upleg grows, the more these gold-stock gains will accelerate.
The bottom line is 2022’s Fed gold anomaly is unwinding. Gold didn’t soar last year as inflation raged out of control in its first inflation super-spike since the 1970s thanks to extreme Fed rate hikes. Those goosed the US dollar into an exceedingly-anomalous parabolic moonshot to multi-decade secular highs. Gold-futures speculators responded with withering heavy selling, pummeling gold to deep stock-panic-grade lows.
But with the federal-funds rate nearing terminal projections, the Fed’s ability to shock traders and heavily distort markets is over. That has fueled sharp mean reversions in both gold and the US dollar in recent months. The resulting young gold upleg is likely to grow much larger with gold now free to start reflecting this inflation super-spike. Gold really ought to double in it, matching the Fed’s monstrous money printing.
Adam Hamilton, CPA