CPI Signals Big Problems Ahead

Apr 12, 2023

CPI Signals Big Problems Ahead

Be careful what you wish for...

Inflation came in today at only 5%.

Isn’t it exciting? This is great news, right?

All we can say is, be careful what we wish for.

We are reminded of the joke about a guy who gets pulled over by a cop for rolling through a stop sign. When the guy rolls down his window he says “What’s the problem officer?” The cop says “You didn’t stop at that stop sign.” Guy says, “C’mon officer, I slowed down.” The officer then asks the man to step out of the vehicle. When he does, the officer takes out his nightstick and starts whacking the guy over the back with it and asks, “Now, do you want me to slow down, or do you want me to stop?”

We are celebrating the fact that inflation came down to 5% when the Fed is pounding the table that they will get inflation back to 2%. That means there is a whole lot more work to do.

We are still getting whacked in the back with a nightstick and we are supposed to celebrate?

It’s not likely to stop anytime soon. Anyone who believes that 2% inflation is likely without a massive recession would do well to remember the wisdom of Warren Buffett. He says, “killing inflation is like losing 20 pounds. The first 10 comes off like a massage, the second 10 like a root canal.”

We are in the root canal stage.

Just one month ago in testimony before Congress, Jerome Powell was hinting at 50 basis point hikes and a terminal rate that could be as high as 6%. How quickly things have changed. Here we are, one banking crisis (solved in the middle of the night) later and the market is pricing in four rate cuts this year.

The divide between what the market expects and what the Federal Reserve has been promising has never been wider. The chart below is from Jim Bianco and shows the large divide between market expectation and Fed “promises.”

Source: https://twitter.com/biancoresearch/status/1645768551553269763

While the Fed says that they will “keep rates higher for longer” the market doesn’t believe them. It’s pricing in dramatic rate cuts beginning in July of this year. According to the pricing on forward interest rate swaps the terminal rate at the end of the year will be 4.44%, not the 5.12% the Fed is indicating.

This is a massive divergence. It’s hard to blame the market for not believing the Federal Reserve.

In June of ‘21, the Federal Reserve dot-plot predicted we would finish ‘23 with a fed funds rate that was 0.625%. Back then the same swaps curve predicted the Fed was wrong and was pricing in much higher rates.

Here we are with a fed funds rate of 4.75% and a promise of another hike in a couple of weeks.

It’s why we must take a true stock of the underlying equation.

If the swaps market is correct, and the Fed must cut four times this year, what is that saying about the state of the real economy?

My twelve-year-old nephew can answer that question. The only way the Federal Reserve cuts four times this year is if it is in response to a serious recession.

Hmmm…

Inflation or recession? What should investors do now is the question.

Keep in mind that we are not tax or investment advisors. We do encourage everyone who is trying to predict what the Fed is going to do, or more precisely what the market is going to do in response to what the Fed ultimately decides, to stop and be aware of the journey we have already taken.

If you bought U.S. stocks…

Apr '23 vs. S&P 500: 4160

Feb '23 vs. S&P 500: 4160

Aug '22 vs. S&P 500: 4160

Jun '22 vs. S&P 500: 4160

Feb '22 vs. S&P 500: 4160

Apr '21 vs. S&P 500: 4160 ¹

Ultimately, if you’ve owned the index over the last two years you’re “even”.

The average price of gold in April '21 was around $1,775 per ounce. However, the price of gold fluctuated throughout the month, reaching a high of around $1,800 per ounce and a low of around $1,680 per ounce.²

Bottom line?

While stock indices are hitting an obvious and recurring wall of supply at these levels, the spot price of gold has risen between 12% to 20%.

Rather than being “even,” and stressed out that your paper portfolio could go south or even disappear in a moment's notice, you could own something that’s tangible, that’s real, that carries zero counterparty risk, and that has outperformed stocks in a significant way. This has been the case over the last two years, over the last five years and over the last twenty years.

Don’t forget that gold does its best work in recessions.

Today’s minutes from the last Fed meeting indicate that their base case is that the U.S. economy will suffer a moderate recession this year.

It’s why the gold party is just beginning as we see it.

Again, we can take a clue from the best investors. Warren Buffett talks about investing in good companies with solid managers who are good stewards of capital. Gold has been proven good. It’s been around for more than 5000 years. It sits in opposition to the dollar, which happens to be managed by some of the worst stewards in our country’s history.

It’s why we continue to believe that…Gold Is A Better Way.

Silver may not be such a bad option either these days.

Take a look at the following chart from silver specialist Tavi Costa.

Source: https://twitter.com/TaviCosta/status/1646232258750345216/photo/1

Costa points out that silver, “a historically undervalued monetary asset, with strong inflation hedging attributes, facing material supply constraints, and now becoming increasingly crucial to the green revolution, is on the brink of a major breakout from a 12-year resistance.”

If the next move in silver is higher, we could see prices moving very quickly toward the $30 threshold. We note that silver closed today at $25.50. ²

Silver, in case you were wondering, bounced in a range between $24 and $27.70 per ounce in April of ‘21. Similar to the S&P 500, silver prices have been relatively flat over the past two years. Silver was priced around $4 per ounce in April 20 years ago. That means it’s up more than 6x versus S&P’s roughly 3X.

Looks like gold and silver are both the better way.

Written by Adam Baratta

Sources:

1. https://www.marketwatch.com/investing/index/spx?mod=home-page

2. https://goldprice.org/