June 2022

Gold and silver prices have been extremely volatile in the past week, primarily as financial market participants have waited for and then reacted to the Fed’s Open Market Committee meeting and decision. All other financial asset prices have experienced the same wild swings.

Gold and silver fell sharply in advance of the FOMC’s decision. The consensus was that the Fed would step up its inflation-fighting efforts by boosting interest rates sharply, by 75 basis points, the largest increase since 1994. It did.

Gold and silver prices then recovered, but fell back in a volatile fashion as financial markets struggled to figure out what the sharp interest rate hike meant for the economy and asset prices.

We will argue that the focus on the Fed is somewhat misplaced. The Fed is responding to an economy facing an array of major challenges, including inflation, strong demand, supply constraints, and the Russian war against Russia.

Many commentaries predict that the Fed’s interest rate increases and balance sheet reductions will throw the U.S. and global economies into recessions in short order. Many of them write that ‘the Fed has caused every past recession.’ They are wrong.

The Fed has not caused past recessions. They Fed has raised interest rates in the past because economic conditions – rising inflationary pressures, mature economic expansions, rising capacity utilization rates and constraints on supplies of many goods, services, and labor, and other economic conditions have pushed a cyclical economic expansion to its limits.

Most of the problems are not related to the Fed’s interest rate policies. Not in the past. Not now. The Fed was in the past and now is responding to the grim circumstances we find ourselves in. To blame the Fed and its interest rate policies for the current dilemma is akin to blaming your aspirin for your fever.

Real Anxiety, Neurotic Anxiety, and Fear

We do not want to seem Panglosian, for the world’s economic, financial, and political conditions are quite grim.

CPM has been stating it expects a recession soon, but our projected horizon has been 2024 – 2025. Not 2022 or 2023. Why so much further out? Because recessions are caused by those capacity constraints. While some sectors of the economy are tight at present, others are not, and overall there remains a great deal of slack and flexibility in the overall economy. Energy, food, and housing, cheap semiconductors are tight. Other sectors are not, as the chart below illustrates.

U.S. Capacity Utilization Rates  

CPM recently paraphrased Amanda Gorman, the United States first National Youth Poet Laureate who read her “The Hill We Climb” at the 2021 presidential inauguration. She wrote an excellent editorial in the New York Times on 20 January this year.  She wrote “… now more than ever, we have every right to be affected, afflicted, affronted. If you’re alive, you’re afraid. If you’re not afraid, then you’re not paying attention.” We prefer to say you should be anxious as opposed to afraid. We do not think you should be afraid. Fear typically carries with it an adrenaline surge and emotional waves that cloud one’s ability to think rationally about proper responses.

However bad economic and financial conditions are at present, they probably are not as grim as many commentators, especially gold and other conspiracy marketeers, make them out to be. Politics; that’s a different matter.

The result is a great deal of fear abroad in all markets. And it is being blown out of proportion by headline grabbers. JP Morgan’s Jamie Dimon this month said everyone should be preparing for an economic hurricane. He said it may be a mild one or a ‘Superstorm Sandy,’ but there is trouble on the horizon. Within hours the fear-mongers were writing that he had predicted the collapse of the global financial system.

Psychologists differentiate between real anxiety, based on real reasons to be anxious, and neurotic anxiety, based on emotions and fears and blown out of proportion. Investors need to practice meditation, take deep cleansing breathes, and stop listening to and believing the yellow press that exploits their worst fears.   

Yes, we have every reason to be concerned about a recession at some point in the next four years. But it will be a storm, and it will pass like every other recession before it. The questions are when it will emerge, how long it will last, how deep it will be, and how much economic damage will it cause. Pre-acting in fear will hasten the arrival of the recession, lengthen and deepen it, and precipitate greater losses to those who have over-reacted out of fear.

It’s Not The Fed To Fear, It’s Everything Else

As stated above, the Fed is reacting to inflationary pressures and other problems. It can seek to moderate inflationary pressures from the demand side of the real economy, by raising interest rates and withdrawing cash from circulation by reducing its balance sheet.

Inflation comes from too much demand, too little supply, and fiscal deficits. The Fed has little power over the other two factors, and those are where the current inflationary pressures mostly are originating.

Also, interest rate increases do matter, but the levels of interest rates perhaps matter more. The chart below shows you how much slack the Fed has to work with at present. The size of increases does matter, but not in the melodramatic way market pundits are saying.

Fed Funds Rates

Is It 1994 All Over Again?

We wish it was. Actually, in some ways the U.S. and global economies are in better shape than they were in 1994. In other ways they are worse than 28 years ago. And monetary policy is in far better shape, despite all of the hand wringing about rising interest rates.

Look at what happened in 1994, since the press and gold and silver commentators have been saying repeatedly that this has been the biggest increase in the Fed funds rate since 1994.

That ‘massive, historic’ 75 basis point increase in interest rates back in 1994 actually was part of a series of Fed Funds rate increases from 3.05% to around 5.45% over the course of that year. Those were much bigger increases from far higher rates than we have seen in this cycle to much higher rates than anyone expected for many years at present.

In 2022 we have gone from 0.08% to 1.75%.  The Fed can tighten a lot more before it ‘throws the economy into a recession.’

More important, there was no recession for seven years after the 1994 75-bip increae. Au contraire, real GDP grow an average of 4.1% per annum from 1994 through the first half of 2000, a very strong performance. Clearly a 75-bip increase in the Fed Funds rate is not a death sentence for economic growth and a sure precursor to recession.

History suggests large upward moves do not presage imminent recession.

Markets have been focusing on size of increases and should be looking at levels.

What It Means For Gold And Silver

There is a storm coming. Investors should prepare. That means reducing debt, building cash reserves, getting rid of weak investments in their portfolio, and buying gold and silver.

This suggests that gold and silver prices should be expected to rise sharply in the intermediate term, between now and perhaps 2026.

In the near term, the next two months, gold and silver prices may not do so well. They will face rising interest rates and market concerns about the state of the world economically and politically. There is seasonal weakness in fabrication demand for gold and silver during the summer months in the northern hemisphere, often leading to some weakening in precious metals prices. Investors may take any such seasonal price weakness as an opportunity to add to their gold and silver holdings.