Fed Musings about Distant Interest Rate Hikes Spook Metals Markets

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by Mike Gleason

Investors who buy into the “transitory” inflation line are being duped

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Well, precious metals markets got absolutely slammed on Thursday. The selling rout followed statements put out by the Federal Reserve suggesting that tapering and rate hikes could come sooner than previously expected.

The U.S. Dollar Index spiked on the Fed’s latest talking points, prompting short sellers in the commodity futures markets to pounce.

Through Thursday’s close, gold had shed more than $100 for the week. As of this Friday recording, the monetary metal shows a weekly loss of 5.4% to trade at $1,782 an ounce.

The white metals got hit even harder during the post-Fed selling spree. Silver prices are down 6.9% since last Friday’s close to come in at $26.10 an ounce. Platinum is taking an 8.2% weekly pummeling to trade at $1,065. And its sister metal palladium has plunged 9.8% for the week to a quote of $2,536 per ounce.

Copper and most other commodities also got hammered this week.

The interest rate markets, meanwhile, exhibited some unusual divergences. The 30-year Treasury yield fell sharply at the same time as shorter-term bond yields and mortgage rates rose. The effect was a dramatic flattening of the yield curve.

Perhaps Federal Reserve chairman Jerome Powell succeeded in convincing markets that the recent inflation spike is transitory. But Powell himself admitted in rambling remarks to the media that he doesn’t really know what the recent data implies about the future.

Jerome Powell: This is, uh, an extraordinarily unusual time. And we we really don’t have a template or, or, or ah, or you know, ah, any experience of a situation like this. So, I think we have to be humble about our ability to understand the data. It’s not a time to try to reach hard conclusions about the labor market, about inflation, about the path of policy. There, there is a possibility on the other side of this that, that uh, inflation could be, could actually be quite low going forward. But that’s, that’s not really where our focus is right now. Where, where our focus right now is, umm, we need to… our, our expectation is that these, uh, high inflation readings that we’re seeing now will start to abate.

Inflation could abate slightly from here or it could accelerate further. But it’s not going away, and the Fed sees it as its mission to make sure of that.

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That means the prospects remain grim for cash savers and bond holders who are hoping to generate enough income to maintain purchasing power. Negative real interest rates are going to be in force for some time to come.

As the Fed’s balance sheet sits at a record $8 trillion and growing, policymakers are now projecting a gradual tapering and two rate hikes in 2023. Who knows if that will actually happen. And even if it does, the Fed funds rate will still be pitifully low versus the Fed’s own 2% inflation benchmark.

Investors who buy into the “transitory” inflation line are being duped. Inflation when measured against nominal interest rates will remain high for the foreseeable future.

Yes, lumber prices and used car prices could come down in the months ahead as supply and demand rebalance.

But there could also be tremendous wage pressure unleashed as businesses struggle to fill jobs amid millions of working-age people still sitting at home collecting government benefits. Inflation could begin showing up in a whole host of areas that aren’t even being talked about yet.

So, despite this week’s Fed-induced carnage in precious metals markets, nothing officials said diminishes the long-term case for owning gold and silver.

Certainly, some near-term technical damage was done. Further momentum selling in futures markets is possible before a final bottom is reached.

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But as we’ve often seen in past episodes where spot prices got smashed, that tends to motivate bargain hunters in the bullion market. In fact, many physical precious metals investors are thankful for this opportunity to accumulate more ounces while they are on sale.

A divergence between a declining paper market and a red-hot bullion market could unfortunately lead to potential shortages in some products and a rise in premiums across the board. That’s what happened to the silver market during last year’s tumultuous gyrations.

Regardless of market condition, bullion buyers would be wise to inquire about premiums before buying a particular product. Often the same quantity of metal can be obtained at a much less overall cost simply by switching from government minted coins to privately issued rounds, for example.

Some dealers try to steer customers into higher-premium products by touting their particular dates or “proof” finishes or purported collectible value. But paying up for any of these features can be a big mistake if your main objective is to accumulate ounces of precious metal for long-term inflation protection.

A big part of any sound inflation protection strategy is keeping transaction costs low. That means staying away from specialty markets within markets where bid/ask spreads are wide, market values are subjective, and scams can be pulled. Sticking with liquid, fungible assets such as widely recognized bullion products ensures the fullest, most direct participation in the underlying bull markets for the metals.

And no, nothing in this week’s market action changes the bullish big picture fundamentals for gold and silver. They remain far sounder stores of value than U.S. fiat dollars which are destined to depreciate.

Well, that will do it for this week. Be sure to check back next Friday for our next Weekly Market Wrap Podcast. Until then this has been Mike Gleason with Money Metals Exchange, thanks for listening and have a great weekend everybody.

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