I have written several articles on the economy and the Fed recently, but I wanted to specifically focus on gold in this article. Precious metals have broken through important technical levels but look a bit overbought in the short term. Regardless, the recent weak economic data and dovish Fed would indicate gold and silver have the potential to finish the year significantly higher.
Price Action and Positioning
Gold and silver have rallied during the last quarter of 2018 and the beginning of 2019. The relative strength might indicate that a consolidation or reversal could persist over the short term. However, I think economic indicators and the Fed will be more important going forward.
During the fall we saw the most extreme managed money positioning ever recorded. The recent price action has reversed the positioning some. Looking back over time, the amount of short interest is still at a relatively high level, which could fuel a price increase if we see further economic weakness.
Central Bank Buying
I wrote a more comprehensive article about central bank buying a few months ago. The World Gold Council came out with a report which highlighted that central banks have bought the most gold in 50 years during 2018. It was a 74% increase compared to 2017.
The buying was primarily driven buy less U.S. friendly countries like Russia, Kazakhstan and Turkey. However, we also had European countries like Hungary and Poland buying gold. There were also list of countries which have not previously been frequent gold buyers. This is clearly a vote of no confidence on the U.S. Dollar, whether it spreads to more countries remains to be seen, but the trend is clear.
The Fed and The Economy
The Fed has gone from four more rate hikes in 2019 and balance sheet normalization being on autopilot to a wait and see approach regarding rate hikes and being open to the idea of pausing QT.
Given the slowing economic data, primarily abroad and some concerning sings in the stock market, auto sales and housing statistics. I don't think it is surprising that the Fed has reversed. What is more perplexing is that the Fed kept such a hawkish tone for so long and then did a 180-degree turn. This has led to a slightly weaker U.S. dollar recently.
It is important to keep in mind that a lot of economic data is lagging. Many argues that the stock market sell-off during the fall was an indication of what will come through in economic statistics during 2019. We have started to see some concerning statistics in the U.S. as well. Auto sales, for example, are now back to levels seen during 2014.
The data for consumers is more mixed, which is illustrated by looking at credit card data for the largest 100 banks compared to smaller banks. During the financial crisis, the largest banks ventured further out on the risk spectrum and had higher charge-off and delinquency rates. This time around, we can see that the delinquency rates for smaller banks is higher compared to what we saw during the financial crisis. Considering that we have had strong GDP growth, it is concerning that some households are struggling already.
Figures 6 & 7
Source: FRED Economic Data
Another factor which I do think the Fed has been looking more closely at is housing data. Housing data is very useful for predicting an economic slowdown. A more pronounced decline in house prices are almost always followed by a recession. The problem is that house data can lag more than other economic indicators. Large parts of the U.S. residential housing markets look good, even though we have seen inventory increasing in many places.
Some more extreme market like Seattle, San Francisco, and San Diego have started to decline some, but the most concerning statistic I have seen is the 11.9% decline in median new houses since the end of 2017. Unless we see a rebound in medium new house prices, I think the likelihood of the Fed turning hawkish again is very low.
Figures 8 & 9
We recently also saw consumer confidence drop to the lowest level in over 2 years. If this continues, it will likely come through in other economic indicators.
The central bank buying could increase the general interest for gold. I also think further rate hikes are unlikely and QT is likely to pause during the year. If we see low economic growth or negative GDP growth numbers, I think the Fed will step back in, as the supply of treasuries will go even higher than it already is and there is a lack buyers outside of the U.S.
When the Fed confirms a pause to QT, gold is set to go higher, and if QE is initiated once again, gold will likely to rally significantly. Whether gold will trade up before that or not is less certain, but I view the risk-reward for gold as very attractive.
Disclosure: I am/we are long GLD, PSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.