Higher Highs Ahead but Running Out of Steam

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This week, we got the CPI and PPI numbers for the month of July. Both fell and were lower than expected on a year-over-year basis. The markets reacted positively to the news because it lowered expectations for the next rate and increased the likelihood of a Fed 180 sooner rather than later. But how reasonable is this expectation?

Inflation numbers may be falling but they remain sky high. The issue for the Fed is the need to get inflation down by lowering demand for goods and services in the economy and thereby lowering prices. But lowering demand causes the economy to slow to the point of recession and, ultimately, depression. Is the Fed willing to go that far to conquer inflation? Maybe, if they’re pulling another 1929.

It was the Fed tightening monetary policy at peak euphoria in the markets that triggered the crash and the ensuing Depression in the 1930s. If they go the same route this time, the dollar will go even higher in the short term and the world will plunge into a global depression. The U.S. would get the blame and the dollar’s status as the global reserve currency would come into question. Chaos would ensue.

By contrast, the Fed—and every other central bank in history—has always ridden to the rescue to avoid collapse. No politician wants a collapse on their watch, not if it can be avoided or kicked down the road for the next person to get the blame. I still believe that the Fed will pull another 180, as it did in December 2018, but just not yet. Ending monetary tightening based on one month of lower-but-still-extremely-high inflation makes little sense. Instead, I believe they will wait to see what the next CPI and PPI numbers say before declaring victory. The impact of the lower inflation numbers in July will solely be to reduce the size of the next rate hike from 0.75% to 0.50%, and that may be it for this hiking cycle. At this point, the Fed Funds rate will be at 3%, 50 basis points higher than the peak in 2018. While the Fed would prefer 3.5% to 4% to be able to cut rates again when the full-blown recession takes hold in 2023, it may not be able to get to that point without causing a systemic collapse… unless of course, that has been their plan all along.

In summary, the Fed is likely not done with rate hikes but the next one is likely to be lower than prior expectations. The big question is: will inflation roll over in August and September and provide justification for a Fed 180 or will the Fed have to continue raising rates until something breaks in the system that forces them to pivot overnight, as they did in March 2020? We’ll have to wait and see. Either way, I believe the Fed will ultimately pivot, but that may be too late for the economy and only serve to provide one last melt-up in risk assets that will be short-lived. Then it’s game over. The end.

GOLD

Meanwhile, Gold has broken out of its Bull Flag and has the 200-day moving average in its sights next. But Gold is becoming overbought in the short-term. Wherever we peak next, I expect a big pullback to follow to either the ~1780 level or to close the gap left behind at 1739. This is aided by my expectation that the current euphoria following the softer inflation numbers is tempered by the Fed. Once we bottom out next, then up goes Gold! A break of 1883 signals 2300+ next.

SILVER

Silver has broken its 50-day moving average and hit a higher high. It is also becoming overbought. I expect a test of the prior closing high of 22 before a deeper pullback to anywhere between 20.50 to 19. Then, like Gold, up it goes. Confirmation that we’re off to 30+ next comes with a break of 22.57 and the 200-day moving average.

GDX

GDX continues to play catch-up with the metals but, as of yet, has still not even tested its 50-day moving average. If we get a big downturn in stocks, perhaps to new lower lows, GDX is likely to be the biggest casualty. Perhaps that is why it is the laggard on the way up. That said, it is nowhere near overbought and has plenty of room to move higher if it chooses to.

SILJ

SILJ, as predicted, is the best performer of all. It has broken out of its bull flag with ease and the 50-day moving average has also been taken out. The problem for SILJ is that it is flirting with overbought readings on the RSI. That said, I wouldn’t be surprised to see a test of the 200-day moving average and/or the prior peak of 12.20 before a deeper pullback in wave 2. When that pullback occurs, this will likely be the last incredible opportunity to buy junior Silver miners, with a stop below the low of 8.36.

SUMMARY

The metals and miners continue to make higher lows and higher highs, aided by the growing expectations of a Fed 180 sooner rather than later. But other than GDX, they are becoming overbought. While I expect them to go even higher yet, there is a bigger pullback coming thereafter, likely due to a bearish change in expectations of a Fed pivot. But as long as that pullback is above the recent lows, it will likely be the last great buying opportunity in this sector for years to come—perhaps ever, imho.