Since mid-April, markets have been increasingly pricing in a bleak outlook for the remainder of 2022. This bleak outlook includes the Fed raising the Fed Funds Rate to north of 3.00% amid tightening financial conditions across the global economy. As the Fed tries to get surging inflation under control, financial markets and risk assets globally have paid the price.
A few charts help to illustrate the tightening financial conditions globally:
Real M2 is contracting at a 3.8% annualized rate. This is the sharpest contraction since May 1980 when real M2 growth was -6.1%.
UBS expects a new high headline CPI number to be reported Wednesday morning. However, the Swiss bank then sees inflation readings declining sharply into the first half of 2023:
The UBS inflation forecast is supported by growing signs of disinflation across the economy, including in the Conference Board’s Index of US Leading Indicators:
Leading Indicators are now in negative territory, and the last three times this index moved into deeply negative territory it coincided with recessions (2000/2001, 2008/2009, 2020).
US corporations are already feeling the disinflationary headwinds. The Citi Earnings Revision Index posted its second worst month in the last decade, almost on par with March 2020:
I’ll add one more feather to the disinflation cap before I move on to the main point of this blog post:
The Homebuilder cancellation rate is surging to its highest level since April 2020.
Are you sensing a trend?
According to Goldman Sachs Chief Economist Jan Hatzius, “There is no doubt that a labor market slowdown is underway.”
The Fed is beginning to achieve its goal of reducing demand across the economy, in turn bringing down inflation expectations. It is likely that we will continue to see more evidence of this disinflationary trend over the coming weeks/months.
The US Treasury yield curve has inverted, a strong signal that a recession may be imminent:
US Treasury Yield Curve (10 year yield - 2 year yield)
In the last few decades, every time the yield curve has inverted a Fed pivot wasn’t far away.
Ok, so you’re probably wondering what’s the point of all this and how can one make money from it.
Good question.
It’s apparent that the global economy has been weakening significantly throughout 2022, and the Federal Reserve will be quick to pivot at the first significant signs of an imminent recession. Market based measures of inflation expectations show inflation moderating close to the Fed’s 2.5% objective by this time next year, as soon as a declining trend becomes evident in the inflation data that the Fed focuses on it will give cover to pause, and then to hint at a potential easing of monetary policy in the future.
Historically, the best times to buy gold since 2000 have been when the Fed is on the cusp of easing. Examples include 2001-2003, 2007-2008, and 2019-2020:
Beginning in 2009, and then again in 2020, the Fed embarked on unprecedented levels of QE that served to supercharge gold rallies that lasted well beyond the most recent Fed rate cuts.
The seasonal trends for gold are powerful from early July through mid-September. In addition, the gold miners are so beaten down (-17% year-to-date) that they are already pricing in much lower gold prices.
I believe we are within 2-3 months of an important Fed policy pivot that will stoke a rally in precious metals and mining shares. Considering the deeply oversold condition of the precious metals sector and the favorable seasonal period that we are now entering, the market may be presenting investors with an unusually attractive buying opportunity with the GDX at its lowest levels since April 2020:
GDX (Weekly - 3 Year)
The GDX is down to levels not seen since 2019/2020 when gold was trading between $1450 and $1550. If gold simply holds above $1700, the GDX could rally 15%-20% as seasonal tailwinds kick in during the next few months.
I am not in a rush, however, in the next week I plan to accumulate a trading position in GDX. This position will have a defined stop loss (risking 10% from my average cost basis once I have a full position) and I will be looking to exit at some point in September.
Alternatively, one could add some of your favorite gold juniors (as long as they don't need to finance in the next couple months). In particular, I would focus on juniors that have already drilled out significant deposits that could be attractive acquisition targets for a mid-tier or senior gold producer.
DISCLAIMER: The work included in this article is based on current events, technical charts, company news releases, and the author’s opinions. It may contain errors, and you shouldn’t make any investment decision based solely on what you read here. This publication contains forward-looking statements, including but not limited to comments regarding predictions and projections. Forward-looking statements address future events and conditions and therefore involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated in such statements. This publication is provided for informational and entertainment purposes only and is not a recommendation to buy or sell any security. Always thoroughly do your own due diligence and talk to a licensed investment adviser prior to making any investment decisions. Junior resource companies can easily lose 100% of their value so read company profiles on www.SEDAR.com for important risk disclosures. It’s your money and your responsibility.
