Gold largely ignoredinflation raging out of control in 2022. Despite the first inflation super-spike since the 1970s, history’s ultimateinflation hedge disappointed. But that unsustainableanomaly driven by extreme Fed rate hikes catapulting the US dollar parabolicwon’t last. Inevitably prevailing goldprices will adjust much higher to reflect this red-hot inflation fueled by epicmoney-supply growth. That’s very bullishfor 2023.
During this past year,the primary US inflation gauge recorded extremes not seen in four decades. The monthly headline Consumer Price Indexaveraged blistering 8.1% year-over-year surges, never printing lower than7.1%. June 2022’s staggering 9.1% peak provedthe hottest CPI since way back in November 1981, fully 40.6 years earlier! And the CPI has been heavily watered downsince, lowballed for political reasons.
Such serious inflationshould’ve lit a fire under gold, fueling massive investment demand. Gold got off to a strong start in 2022,surging up 12.1% year-to-date in early March. But that was a geopolitical spike on Russia invading Ukraine, which wasn’tsustainable. From there gold collapsed20.9% over the next 6.6 months into late September. That left it down a shocking 11.3% YTD in theworst inflation year since 1981!
That gaping gold-inflation disconnect made no sense, leaving investors increasingly bearish. But gold’s brutal mid-2022 plunge was anextreme anomaly driven by the Fed scrambling to stuff that inflation genie backin the bottle. Between mid-March to earlyNovember, the Federal Open Market Committee hiked its federal-funds rate anastounding 375 basis points. That includeda shocking streak of four monster 75bp hikes!
As those frantic rate hikes accelerated,the benchmark US Dollar Index skyrocketed up 14.3% between mid-April to lateSeptember to hit a stunning 20.4-year secular high. That unleashed enormous gold-futures selling,slamming gold 17.9% lower in that span. That accounted for 6/7ths of its mid-year plunge, and had nothingto do with inflation. But it exhaustedgold-futures speculators’ capital firepower for selling.
So gold bouncedstrongly since, powering up as much as 12.1% into late December despite anotherbig 50bp Fed rate hike! With major gold-futuresmean-reversion buying underway, that selloff anomaly has passed. That clears the way for gold to start reflectingthis raging inflation. Ironically thatwasn’t spawned by the Fed’s zero-interest-rate policy after the pandemic-lockdownstock panic, but the Fed’s epic money printing.
Between late February2020 to mid-April 2022, the Fed ballooned its balance sheet a shocking 115.6%higher! It brazenly conjured $4,807b of newfiat dollars out of thin air in just 25.5 months to monetize US Treasuries andmortgage-backed bonds! That more thandoubled the US-dollar supply in just a couple years, seeding the subsequentraging inflation. Money supplies arewhat drive general price levels, not rates.
Legendary American economistMilton Friedman proved this in the early 1960s, after studying and writing hismassive opus “A Monetary History of the United States”. From those pages sprung his most-famousquote, “Inflation is always and everywhere a monetary phenomenon.” Relatively-more money bidding up the priceson relatively-less goods and services is the root cause of inflation, which isthe Fed’s responsibility.
Hiking itsfederal-funds rate an exceedingly-aggressive 425 basis points in just 9 months thisyear can’t slay inflation. Instead theFed has to destroy the lion’s share of that $4,807b of new dollars that itcreated in its fourth quantitative-easing campaign. That process has begun with the Fed’s secondquantitative-tightening one, but it remains small. As of late December, QT2 has only reversed1/13th of QE4 so far!
The Fed’s balance sheetremains grotesquely bloated, $4,406b higher than before March 2020’s stockpanic. QT2 is supposed to be running at $95bper month of monetary destruction, but so far has only averaged $71b. Even if the Fed finds the courage to ramp QT2to that promised pace, it would still take over 46 more months to fullyunwind QE4’s vast monetary deluge or 23+ months to merely reverse half!
So that epic flood of newQE4 money is going to continue sloshing around the US economy for years. No matter how high the Fed hikes rates, biginflation will persist with a monetary base still 105.9% higher than pre-paniclevels. That’s super-bullish for gold,which is history’s ultimate inflation hedge because of its naturally-constrainedmined-supply growth. That only grows onthe order of 1% annually, far less than money.
This chart overlaysgold and its key technicals on the monthly headline CPI’s year-over-year changesin the last few years. Gold isdramatically lagging this biggest inflation super-spike since the 1970s,which has really vexed investors. Butthat is changing as gold-futures speculators normalize their excessively-bearishbets spawned by mid-2022’s parabolic US-dollar surge. Gold will increasingly reflect inflation in 2023!
No bones about it, gold’sperformance during this latest Fed-spawned inflation super-spike has been poorto dreadful. Though an extreme pandemic-lockdowndistortion, the trough CPI came in May 2021 up a trivial 0.1% YoY. That month gold averaged $1,850 on close. Despite inflation soaring vertical sincethen, gold has only averaged $1,795 so far this month. That’s down 3.0% through this inflation super-spike!
But it gets worse, as withoutlockdowns the CPI trough would’ve likely hit in November 2020 up just 1.2% YoY. Gold averaged $1,868 then, making for a 3.9%loss since. That’s incrediblydisappointing, contrary to all historical precedent. With the worst inflation raging since 1981 atthe tail end of the previous super-spike, gold probably should’ve doubled by now. That would have made for $3,750ishmonthly-average prices!
Gold reacting sopowerfully to an inflation super-spike may sound crazy, but it’s actuallyconservative. In the entire modern monetaryera since August 1971 when the US dollar was severed from its gold standard,there have only been three inflation super-spikes. Gold did far better than doubling during the firsttwo back in the 1970s. Investors flockedto it as inflation ravaged stocks and eroded dollar purchasing power.
That’s certainlyevident in this next real gold chart, comparing CPI-inflation-adjusted goldprices to the monthly headline CPI prints during that 1970s decade. Gold prices are rendered in constant November2022 dollars per the latest CPI, making them comparable with today’s. But all the gold upleg gains and correctionlosses are noted in actual nominal terms. Gold was a moonshot in those last inflation super-spikes!
The first inflationsuper-spike ran between June 1972’s CPI trough up 2.7% YoY to December 1974’speak soaring 12.3% higher. During that30-month span, monthly-average gold prices from those trough to peak CPI monthssoared up 196.6%! Gold nearly tripled during that first inflation super-spike soon after the dollar gold standard wasslain. Investors wisely used gold toprotect their capital from inflation’s predations.
The second much-largerinflation super-spike erupted right on its heels, spawning at November 1976’s+4.9% YoY CPI trough. That ultimatelypeaked 40 months later in March 1980 with the CPI blasting up a soul-crushing14.8% YoY. Monthly-average gold prices skyrocketeda colossal 322.4% higher during that span, literally more than quadrupling! Yet again raging inflation fueled massiveinvestment demand for gold.
After effectively triplingand quadrupling during the only other inflation super-spikes seen in thismodern monetary era, does it make sense for gold to languish flat to lower inthis latest? Hell no! While gold’s gains this time around probablywon’t be as huge with today’s far-larger aboveground gold supplies, a doublingisn’t a stretch at all. Despite way moregold, the growth in global fiat-currency supplies dwarfs that.
The best estimates I’veseen for total aboveground gold stockpiles peg them near 75k metric tons backin 1970 and about 210k today. That’s up 180%in five-plus decades, around a 2% compound annual growth rate. During that same span the Fed’s broad M2 money-supplymeasure has shot stratospheric from $590b to $21,347b, up about 3,500%! That roughly 7.2% compound annual growth rate more than triples gold’s.
And that’s just USdollars. The Japanese yen, formerpre-euro European national currencies, and the euro saw similar if not largermoney-supply growth over this past half-century! So relative to the endless supplies of fiatcurrencies spewed into the world, gold is more precious today than during thoselast inflation super-spikes. Onceinvestors really start worrying about inflation, there’s not much gold to goaround.
So far inflation’s corrosiveand devastating impacts on investment portfolios have been underestimatedradically, but that will likely start changing in 2023. The Fed’s uber-hawkish jawboning and extremerate hikes have convinced investors higher interest rates will kill inflation. But the Fed is peddling snake oil, the onlyway to stake this inflation super-spike is destroying the lion’s share of thatvast QE4 money printing.
When even lowballedheadline CPI inflation remains stubbornly high in 2023 despite 425 basis pointsof federal-funds-rate hikes in 9 months, investors’ faith in the Fed will beshaken. And several factors willincreasingly contribute to higher general awareness of inflation’s ravages. These include ending artificial suppressionof gasoline prices, a lower US dollar boosting import prices, and weakercorporate earnings.
Americans perceiveinflation most in things we must buy often, led by gasoline and groceries. The latest November CPI subindexes for thesesurged 10.1% and 10.6% YoY. Gasoline priceswould’ve been way worse without the Biden Administration’s unprecedented artificialsuppression of prices ahead of 2022’s midterm elections. The wartime US Strategic Petroleum Reservewas ordered to release 180m barrels of oil!
That temporary supply floodforced crude-oil and gasoline prices much lower, considerably lesseningAmericans’ perceptions of inflation. Butthat political stunt drained roughly 40% of the SPR, leaving it at its lowestlevels since the mid-1980s! Without thatmarginal supply, oil and gasoline prices are heading back higher. That will again ramp awareness and concernabout this raging inflation among investors.
And as everyone feedinga family knows, food prices are soaring far faster than the watered-downCPI suggests. Americans’ grocery billsare probably up about 20% to 30% YoY, not just 10%. Some of that is evident in the wholesaleProducer Price Index, which isn’t as politically-charged. Over this past year for example eggs, vegetables,turkey, and pasta prices have soared 244.1%, 80.6%, 37.6%, and 32.8% YoY!
2022’sexceedingly-strong US dollar on those extreme Fed rate hikes also reallymitigated the impact of inflation. That higherpurchasing power relative to other major currencies made the vast quantities ofgoods the US imports cheaper. But as thedollar weakens in 2023, import prices will rise proportionally. Those higher prices for a sizable fraction ofoverall US GDP will also boost perceptions of raging inflation.
But the dominantinflation concern for investors will be its increasingly-dire impact on stockmarkets. That is what will ignitemassive gold investment demand for prudent portfolio diversification! Persistently-rising general price levels reallyerode corporate earnings. Companiesare forced to pay more for their inputs, but can’t pass along all those highercosts to customers. They will eventuallybalk, risking lower revenues.
That pinches profits, aserious problem when stock markets are really overvalued. That’s certainly the case now, with the eliteS&P 500 companies averaging trailing-twelve-month price-to-earnings ratiosof 28.5x entering December. That’s stillin formal bubble territory, which starts at 28x! And that’s despite the S&P 500 alreadybeing down 20.6% year-to-date. 2022’s youngstock bear has only just awakened.
The US stock markets wouldstill have to be cut in half to hit their historical fair value of 14xearnings! The longer this bear persistsand the deeper it mauls stocks, the more investors will up their tiny portfolioallocations in counter-moving gold. Those remain effectively zero, as seen in the ratio between the value ofthe leading and dominant US gold exchange-traded funds and the S&P 500’s overallmarket capitalization.
According to the WorldGold Council, exiting Q3’22 GLD and IAU accounted for 40% of all the gold heldby all the world’s physically-backed ETFs. That totaled 1,359 metric tons entering December, which was worth$77b. Yet the elite S&P 500 stocks’collective market cap then was $36,346b, implying American stock investors hadgold portfolio allocations on the order of 0.2%. During an inflation super-spike no less!
If those climb to 1% or2% or maybe even 5% in coming years, gold could easily double. Inflation slams stock markets, resulting higherinterest rates crush bond prices, and cash’s purchasing power relentlesslyerodes. Millennia of history have provengold is the refuge of choice during inflationary debasements of currencies. Gold powers higher on balance on growinginvestment demand during such dangerous times.
Gold will startreflecting this raging inflation more in 2023 as the scales fall from investors’eyes. They will see high inflationpersisting despite 425 basis points of Fed rate hikes in 2022. They will realize higher rates aren’t theinflation panacea Fed officials claimed. With that blistering hiking cycle already 85% done relativeto Fed officials’ terminal federal-funds-rate projections, they’ll know the Fedis running out of ammunition.
Investors’ inflation worrieswill really ratchet up as corporate earnings continue weakening, feeding this ravenousstock bear. Higher gasoline prices and alower US dollar will exacerbate perceptions inflation is still raging out ofcontrol despite the Fed’s extreme rate hikes. As their stock-heavy portfolios burn with mounting losses, they’llincreasingly remember gold. Huge capitalwill be reallocated into this inflation hedge.
Soaring gold investmentdemand will drive much-higher gold prices. The biggest beneficiary will be gold-mining stocks. The leading GDX gold-stock ETF is already up 37.4%at best since late September, which amplified gold’s parallel 12.1% mean-reversionrally by 3.1x. And the smaller fundamentally-superiormid-tier and junior miners we specialize in well outperformed that. Their upside potential in coming years is huge!
Researching and tradingthe better mid-tier and junior gold stocks has been our specialty at Zeal for over two decades now. We aggressively added new trades at fire-saleprices in recent months surrounding gold’s bottoms, filling our newslettertrading books. Their unrealized gainsare already running as high as +76.8% this week! All speculators and investors needgold-stock portfolio allocations given gold’s bullish outlook.
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The bottom line is goldwill increasingly reflect this latest inflation super-spike in 2023. Gold investment demand will return with a vengeanceas 2022’s illusions are dispelled. Ashigh inflation persists, investors will realize extreme Fed rate hikes areineffective in slaying it. Confidence inthe Fed will collapse as it runs out of room to keep hiking. Investors will increasingly worry inflationwill rage much longer than they hoped.
That will ravagecorporate earnings, hammering still-overvalued stock prices much lower. As this young bear deepens, investors will increasinglyseek to diversify their burning stock-heavy portfolios. They will remember gold being the ultimateinflation hedge, and start shifting capital into it. With gold allocations now effectively zero,there’s vast buying coming which will fuel powerful bull runs in gold and its miners’stocks.
Adam Hamilton, CPA
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