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Much FOMC About Nothing

Ah, Federal Reserve meeting days. So much fun.

First the Fed committee that decides on interest rates and bond purchases (the FOMC) released the minutes from its meeting. The meeting notes pulled the timeline for rate hikes forward as per the dot plot (which plots projections from FOMC members about what interest rates will do in the future) but specifically stated no change now or particularly soon.

The green line shows the median expectations for interest rates from the 18 members of the FOMC for each year. Pay attention: while rate hike expectations have climbed, the average for 2022 is still just 0.3%, which means one rate hike over the year. Pretty minimal.

The meeting minutes also said that tapering of asset purchases “may soon be warranted”.

No surprises there. There was no expectation that they would raise rates, as the Fed always projects its moves and has not talked about raising rates soon. That they expect to raise next year if inflation keeps running is a given; it’s their state mandate. And everyone expected that they would talk about tapering.

In response gold gained about $10 an ounce alongside US equities, which moved higher.

Then Fed Chair Jerome Powell took to the stage and started talking. He added some insight into tapering, saying it would start “soon” and be completed by the middle of 2022. Whew. That’s a fairly aggressive taper, given that the Fed currently buys $120 billion worth of bonds every month.

Powell did take pains to emphasize that financial conditions would remain accommodative even after the Fed stops buying bonds and that decisions on the bond-buying program were separate from any actions on interest rates.

Ya right. You can’t have one without the other… What I mean is: last time the Fed tried to tighten, it started with rate hikes and then tried to taper bond purchases. That didn’t work: traders had barely tolerated consistent rate hikes in 2018 and they refused to also accept tapering. Markets corrected 17% in three months and by early 2019 the Fed had stopped tapering and lowered rates again.

This time around, the Fed is trying it the other way around: taper first then hike.

I don’t think the market will let them get far.

And as you all heard from me last week, I expect the markets to throw a fit as soon as tapering begins. Like a kid who tantrums because he or she has learned it achieves the desired goal, the market has learned that sliding/correcting/crashing in response to a withdrawal of support now forces the Fed to backtrack and reinstate the supports it was slowly and carefully trying to withdraw.

And I think that entire process will be the push that gold needs. Gold goes with the start of tightening, as it’s official validation of inflation and gold is the first and best inflation hedge. Gold then usually struggles as tightening continues because real interest rates rise…but I don’t think tightening will continue this time. And when the tantrum forces the Fed back, I think gold will really shine as it becomes glaring obvious that negative real rates are Here. To. Stay.

That pattern didn’t really start today: gold gained when the Fed minutes first came out then dropped as Powell spoke. The gain and fall were both pretty small though, so really gold didn’t do much. Fair enough, as tapering is still six weeks off at the earliest (the next Fed meeting is early November).

Other reactions were also pretty muted, especially compared to the action at the start of the week when markets around the world fell (on average 5%) on fears the massive Chinese real 4 estate developer Evergrande would default on its debts and collapse, leading to contagion across China and perhaps beyond.

Though it wasn’t just Evergrande, in my humble opinion. Evergrande was, for a moment, the scapegoat for fears that the market needed to correct. And such fears certainly have some grounding.

  • Inflation is strong, bringing markets closer to tapering and rate hikes. In today’s meeting minutes the Fed boosted its outlook for 2021 inflation by 0.8% to 4.2%, which is of course double the Fed’s long-term inflation target.
  • Profit margins, EPS revisions, and forward EPS growth have all peaked as the COVID recovery period ends and we have to live with reality.
  • Continuing the above thought, global growth momentum is falling. For its part, the Fed downgraded its GDP growth projection for 2021 to 5.9% from 7% previously.
  • Recent slides have pulled many markets below their 50-day moving averages.

This is all to say that a tantrum would not come out of the blue; traders would be able to argue that they were selling on fundamentals, not just in an attempt to push the Fed around.

This is all-important…and not. It’s important for gold, to be sure, but a lack of reaction across most base metals shows that growth will likely just carry on, whatever happens with markets and macroeconomics.

I don’t mean to say that a stock crash would not impact growth. But I do mean to say that lots of commodities, including copper, nickel, and uranium, don’t care about the details of tapering and rate hikes. Is that because traders agree with me that tightening won’t actually happen, so they don’t have to worry about it slowing growth? It’s certainly possible.

The charts above, courtesy of Canaccord, show that iron ore took it on the chin in the last few weeks as Evergrande raised fears of a major Chinese crash. But steel, copper, and aluminum stuck their ground. At the end of the day, supplies for these commodities are tight, demand keeps rising, and outlooks are bullish. In other words, those metals are trading on fundamentals. Imagine that!

I’ve discussed (complained about) the lack of a gold equity market despite a strong gold price. Things aren’t quite as bad for base metals…but base metals equity markets aren’t exactly strong. Here’s one capture of that: this chart from Scotiabank shows the copper price implied in each copper company’s share price. (To do it, they figure out what copper price makes a company’s total net asset value, at a normal 8% discount, equal its market cap.)

The red dashed line at the top is the current copper spot price and the bars show each company’s implied copper price.

Of course there are company-to-company differences here but there’s also a clear sector-wide discount in play. That doesn’t matter if you think copper is currently overvalued and that the price will be lower in the near future; if that’s the case, stocks are just forward looking.

But if you are bullish on copper then these discounts can’t persist. I said it recently and will say it again: if you’re bullish on copper, build a position and then wait. The market will happen. It may not happen overnight so don’t expect immediate returns, but it will come.

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