Gold Will Shine If The Labor Recovery Stalls

May 24, 2021 1:35 PM ETGLD, GDX, NUGT, IAU, GGN, PHYS, DUST, SGOL, GLDM, BAR, RING, AAAU, SGDM, ASA, GOAU, GOEX, OUNZ, QGLDX, JGLD, PHYS:CA5 Comments
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China Enthusiast
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Summary

  • If the labor market recovery stalls, interest rates and the dollar will fall.
  • Inflation will stay elevated even if the labor recovery stalls.
  • Gold will perform well against this backdrop.
  • The odds of a slowdown in the labor market are increasing.

Golden Piggy Bank with 2021
Photo by asbe/iStock via Getty Images

There is a rising probability the Fed will be perceived to be ineffective in managing the economy in the coming few months, which makes gold and gold miners attractive short term assets to own.

The Fed has three key challenges right now.

  1. They want to promote a strong jobs recovery, which still has plenty of slack to get back to pre-pandemic levels.

2. They want to avoid having prices rise too quickly.

3. They want to prevent asset bubbles from forming.

The Fed is under the impression that loose monetary policy is needed to promote a labor recovery, so asset bubbles and inflation are tolerable side effects to a policy designed to get people back to work. I believe there's a significant chance the Fed is wrong.

If I'm right, the Fed's poor read of the current situation will have a significant impact on asset prices, for which gold will be an effective short term hedge.

It's always important as an investor to plan for contingencies. I think the most important contingency to plan for right now is what happens if the labor recovery slows down? What happens if don't see another 500K+ jobs report like we saw in February and March? What will the Fed do, and what will happen to asset prices?

Later in this post, I'll explain why I think the labor recovery will turn anemic in the next couple months, but for now, let's just explore this as a possibility, and understand why it would be the perfect backdrop to own gold in.

I don't think it's reasonable to expect the Fed to consider tapering bond purchases or any other form of monetary tightening if the labor recovery turns anemic.

Long term interest rates would likely fall, as the market prices in a lower likelihood of near term tightening. The dollar would also likely fall in value if growth in the U.S. weakens just as the vaccine rollout globally accelerates.

Inflation will likely stay hot in the coming few months, regardless of whether the labor market recovers or not. Not because of transitory inflation drivers, but rather longer term inflationary forces in housing and energy.

Housing prices feed into inflation data, with about an 18 month lag. We're just now reaching the point where I expect the recent rapid rise in home prices to begin to feed into CPI data.

Home prices (Red) lead CPI measurements of housing inflation (Blue) Source: S&P/Case-Shiller U.S. National Home Price Index

It's important to note that the elevated inflation prints we've seen in recent months had some of the lowest housing inflation numbers we've had in recent years, as the surge in home prices has yet to flow into the data. Housing, which is about 40% of inflation readings, is set to rise off of its recent lows for a considerable time period going forward. This will be a boost for inflation readings, and it likely won't be transitory.

Energy costs have also risen dramatically. I expect the cost of energy to stay elevated through the summer as the global vaccine rollout increases demand. The Energy Information Agency is expecting oil markets to remain in a supply deficit for the coming few quarters as a result of this, and I believe the EIA may be underestimating the size of this coming deficit.

As Art Berman points out, due to the lagged impact of oil rig counts on production, U.S. oil production may actually decline into September. This would be a boost for oil prices if it happens, which are already up about 100% over prior year levels.

U.S. oil production may fall in the coming months, just as demand is set to surge. Source: MacroVoices Crude Update April 22, 2021 - Art Berman

To summarize, if the labor recovery weakens, interest rates and the dollar will likely fall. And regardless of what happens with the labor market, inflation will likely stay hot. Weakening dollar, falling real rates, and high inflation…Anyone that knows anything about asset markets knows that's the perfect backdrop to own gold, and to be very careful in what else you own.

But this has all been contingent on if the labor recovery weakens. Now I want to talk about why I think there's a high likelihood the labor recovery will weaken.

Companies get serious about hiring when they have confidence in the future. This is difficult to have in the massively distorted economy we are currently in. I find myself struggling to envision anything beyond the next few months in terms of economic trends. I can't imagine people in charge of hiring decisions have much more clarity than I do.

Monetary and fiscal policy have worked in tandem to create an environment where it's impossible to develop a clear vision for the future, which is a requirement when making most long term investments like hiring. Here's one key example of how this is taking hold.

Incomes skyrocketed during the pandemic, as seen in the red line below. This helped drive record consumer spending, and some of the best short term economic data ever produced in this country. Unfortunately, incomes excluding transfer payments from the government (blue line) have only recently begun to show anemic growth.

Source: Real personal income excluding current transfer receipts

Who knows what demand is going to look like once these transfer payments subside in the coming months. We know it's going to have an impact, but how much? If I were a business owner, I'd likely remain conservative in my hiring plans for any long term roles until I have a sense for what long term demand is going to look like, which is impossible in the current environment.

This isn't just my own speculation either. The NFIB survey of small business owners confirms this view of general uncertainty regarding future business conditions:

Source: Small Business Economic Trends | NFIB

I contend that the 500K+ jobs reports in February and March were outliers, driven by the dramatic reduction in Covid risk and associated reopening that happened during that time period.

Covid risk dramatically declined in February and March. The vast majority of the reopening is behind us now. Source: Coronavirus in the U.S.: Latest Map and Case Count

The marginal benefits of reopening to the U.S. economy are limited now, as most of the economy has already reopened. I believe due to this, and the economic uncertainty created by the Fed, blowout job reports are unfortunately a thing of the past. The market is overestimating the future rate of this economic recovery. Gold and gold miners are attractive to own in the near term as the market comes to terms with the reality of stagflation in the next few months.

This article was written by

China Enthusiast profile picture
201 Followers
I am passionate about macroeconomics and financial markets. I focus on economic growth and inflation, and my view of those two variables drives my investment strategy.

Disclosure: I am/we are long GOLD, AUY. 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.

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