The Threat of the Taper

Gold takes hit as US economy heat increases taper expectations

The gold price declined -6.4% this week to US$1,774/oz, including one of its worst daily declines in history, as rising inflation in the US is leading the market to expect a tapering of the ongoing monetary expansion.

A look at the H1/21 stars of metals and metals ETFs

With H1/21 nearing a close, this week we look at the H1/21 stars of metals and metals ETFs, with the base and specialty metals clearly standing out, precious metals prices lagging, and most of the precious metals ETFs seeing substantial declines.

Producers and juniors both hit substantially by gold decline

The producers and juniors fell abruptly, with the GDX down -10.3% and GDXJ down -10.2%, and most of the Canadian juniors declining, with many seeing their weakest week in several months, on the major decline in gold on taper concerns.

1) Gold takes major hit from threat of taper

Gold down on anticipation that inflation may prompt Fed into monetary taper Gold was down -6.4% this week to US$1,774/oz, after several weeks hovering around the $1,900/oz level, as a substantial rise in inflation led by a surging US economy has led many to anticipate that the US Federal Reserve may need to pull back on the aggressive monetary expansion of the past year to curb rising prices. The Fed this week held rates steady, but substantially boosted its inflation forecast and is now forecasting at least two rate hikes by the end of 2023. So far the major jump in inflation has been only in the US, spiking to 4.93% in May 2021, its highest level since 2008 during the global financial crisis (Figure 4). While inflation in Europe has picked up in 2021, it is still just at 1.62% as of the most recent April data, and well below its most recent highs of 3.90% reached during in 2008. Japan, which has struggled with deflation for years, has actually seen its CPI go negative for most of 2021, with the CPI down -0.49% year on year in April 2020, still far below its recent inflation highs set in 2014.

US and EU retail sales picking up past pre-crisis levels

Recent US retail sales figures are reflecting an economy that is really heating up, which could mean more inflation to come, and is in keeping with the surge in job openings and falling unemployment that we covered last week (see the June 11, 2021 weekly for more). US Advanced Retail Sales rose 24.4% year on year in May 2021, far above the 3.6% average in the two years leading into the crisis, but down from the massive 48.1% jump in April 2021 (Figure 5). While these figures were off very low bases, with April and May 2021 at the depths of the global health crisis, retail sales have now risen a substantial 22% above pre-crisis levels, from $460trn in February 2020, to $560trn as of May 2020.

Another related indicator, US Personal Consumption Expenditure, available to April 2020, shows a similar picture, with the nominal figure up 28% in April 2021, and the real figure up 24%, implying inflation of about 4.0%, similar to US CPI inflation (Figure 6). The growth of European retail sales index has also picked up substantially over 2021, reaching 22.1% year on year as of the most recently reported April 2021 data (Figure 7). However, interestingly, its retail index, at 111.1, has not surpassed the precrisis level of 111.7 in January 2020, which in part is because of the lower inflation rate.

The Fed may have seriously difficult implementing a strong taper

The CPI inflation and retail sales data above show that high inflation has not morphed into a global problem yet. However, inflation in the US can become a global problem as the US$ remains the reserve currency, meaning that US inflation can drive global distortions because of the wide use of the US$, adding more pressure on the Fed to manage the situation carefully. So far Fed officials have started to 'hint' at a taper of monetary stimulus, but several Fed Board Members have also said that it is too early in the recovery for any aggressive taper of the current monetary expansion, and rate hikes remain off the table until 2022 at the earliest.

We believe that the Fed may have serious difficulty implementing a strong taper, and later rate hikes, as the structural situation in the US economy is quite precarious, being almost entirely propped up by stimulus that is simply not sustainable, while valuations in the equity market and housing markets have gone stratospheric. It would not take much in the way of interest rate hikes, in our view, to pop these bubbles, and induce a 2008-2009 global financial crisis-style fallout. We believe that the Fed will obviously try to avoid something like that at any cost, and therefore it is likely it will continue to 'play chicken' with inflation, letting it remain well above the Fed's mandate for around 2.0%.

Fed 'Playing chicken' with rising prices: Rate surge, hyperinflation or Goldilocks? We are already seeing this, with inflation now nearing 5.0%, way out of these bounds already, and yet the Fed is still only 'hinting' at action, but really taking any yet. We believe that a situation where inflation continues to pick up, but not so much as to drive the Fed to taper aggressively or raise rates earlier than expected, could actually be good for gold, the longer it goes on, in the short-to-medium term. And if inflation gets truly out of control, which is quite possible given the epic amount of US dollars created over the past year, this would almost certainly drive a surge in gold.

However, such a surge could be short-lived, as the Fed could be forced into taking action (similar to Fed Chairman Paul Volcker's inflation and economy hammering hikes in 1980-1981) and massively increase interest rates. As we saw in the early 1980s, such a scenario can be tough on gold and gold stocks, and is therefore a risk we need to consider. Hyperinflation might look good for gold for a while, but the potential for a dramatic tightening in response could drive a major crash (not just in gold, of course, by also the overall economy and equity markets).

However, such a major rate hike, even in the event of inflation moving substantially above 5.0%, which would be very likely to crash this 'everything bubble' may not prove a politically viable option. In fact, given a heavily indebted government and population, it almost seems that hyperinflation could be more politically tenable than a major rate hike! Such an unfettered hyperinflation would obviously send the price of gold and gold stocks soaring, utterly the devalue the dollar and US$ denominated debt and cause epic global economic distortions (and likely political, in the aftermath); a Great Reset, indeed.

Between the extreme poles of economy-crashing rate hikes and the utter distortion of hyperinflation, of course, is the 'Goldilocks' scenario (or one that is 'just right') where we have high inflation for an extended period, and the Fed is able to edge up rates just enough to keep it from getting out of control. This would propel both gold and gold stocks, and be the ideal scenario. However, we would suggest that this balancing act, in a world of imbalances currently, could prove to be tricky.

Markets cautious, but certainly not pricing in a major taper yet What are the markets showing us about their expectations for a taper and rate hikes? The bond market certainly doesn't seem concerned for now. We would expect any major fears of a rate hikes to drive up bond yields, but over the few months since taper talk began, they have been contracting, from a peak of 1.75% near the end of March 2021 to just 1.51% currently, not rising. While the stock market surge has slowed over the past two months on inflation concerns, the S&P 500 continues to edge up to new all-time highs, and the market seems to expect that any pressure from rising rates may be offset by gains from inflation in revenue and earnings.

In practice, what we may have right now is the 'Goldilocks' situation we referred to above, where inflation is picking up, but not so much to drive the Fed into major tightening. While it is certainly questionable how long this can go on, for now, if inflation continues up without major Fed action (not just talk), gold should be supported, regardless of the recent short-term sell off, and a price above US$1,700/oz can continue to drive a strong period for the industry. In the case of extreme tightening, gold could get hit in a 'sell everything' moment, but as seen in previous cycles, there could be a flight to gold for safety, as in 2020 (we note that this does not always work; in the 2008 crash, gold went down with the rest of the market).

However, in the aftermath, the Fed would almost be certain to again loosen monetary policy significantly, which would send gold once again soaring. The only thing that could really keep gold subdued for a substantial period in our view would be a cycle of strong growth with almost no inflation, which was the case in the gold bear market from 2013-2018, but as we are seeing, with the inflation genie back out of the bottle, this rare situation is likely to be repeated in the current cycle.

2) Metals and metal mining ETFs starts of H1/21

Base metals are the stars of H1/21 while precious metals lag With H1/21 coming to a close, this week we take a look at the stand-out performers for the metals and major metals ETFs over the first half of this year. The clear stand outs have been base metals, with tin surging 48%, iron ore up 25%, and copper up 19% (Figure 9). These are geared to the industrial cycle and have been propelled by a major global economic rebound, but gains at a similar pace to H1/21 seem unlikely to be sustained over H2/21, as a big part of this was because of the very low base set in mid-2020. We are seeing the growth rates for iron ore and copper contracting over the past month, although the tin growth rate has kept rising. Other industrial metals zinc and platinum, have gained moderately, with both up 4%.

The precious metals have lagged the major metals in H1/21, with gold down -9% and silver down -5%. However, they recovered significantly over the second quarter, after gold reached a low down 13.6% as of March 8, 2021 and silver hit a low down -11.8% on March 20, 2021. While taper talk may continue, we don't expect it be followed up with much action in the short to medium-term, with no concerted tapering likely soon and rate hikes still likely at least a year off. In the meantime, with inflation taking off, and likely having room to further increase before any clampdown, gold, which is driven mainly by monetary factors, is likely to be supported, and silver could also benefit, as it is driven by a mix of monetary and industrial use factors.

Substantial declines in gold ETFs, juniors see the biggest dip

The Gold ETFs saw substantial declines over H1/21, with a largest part of the loss over just the past week. For the larger miner ETFs, only the VanEck Gold Miners ETFs outpaced the gold price, down -5%, with the Ishares Global Gold and Sprott Gold ETF down -10% (Figure 10). The junior miner ETFs were also down, with VanEck Gold Juniors down -10%, Global X Gold Explorers declining 13%, and Sprott Junior Gold sliding -15%, as they tend to be more leveraged to changes in the gold price.

ETFs for base and some specialty metals strongest, silver lags

The only strong metals ETFs performances came from more specialty metals, with the Global X Uranium ETF up 39% and the Rare Earth Metals ETF up 14%, and copper, with the Global X Copper Miners ETF up 10% (Figure 11). The MSCI Global Metals and Mining ETF gained 14%, likely driven by its weighting to copper and other base metals. The Global X Lithium & Battery ETF was near flat, down -2% while the Gold and Precious metals ETF declined -5%, above other gold ETFs likely because of a pickup in platinum and palladium. The silver ETFs were weak similar to the gold ETFs, with the ETFMG Prime Silver Junior Miner ETF down -9%, the Global X Silver ETF down -10% and the Ishares Silver Metals & Mining ETF down -13% (Figure 12).

Producers all down substantially on gold price drop

The major gold producers were all down on the fall in the gold price and concerns that inflation would push the Fed to curb monetary stimulus and raise rates earlier than expected (Figure 13). News flows included drilling results from Pretium's Phase 2 North Block expansion drill program at Brucejack, Yamana reported its 2020 Material Issues report and Alamos reported drill results from surface and underground exploration at the Island Gold Mine (Figure 15).

Canadian juniors mostly rise

The Canadian juniors nearly all down this week on the decline in gold (Figure 14). For the Canadian juniors operating domestically, there were drilling results from New Found Gold and Amex Exploration (Figure 16). For the Canadian juniors operating mainly internationally, Rupert reported drilling results from Ikkari, Bluestone released infill drilling results from Cerro Blanco and Gabriel closed its US$6.0mn non-brokered private placement, to be mainly used to fund its arbitration case with Romania over its mine in an area being nominated at a UNESCO World Heritage Site (Figure 17).