Gold, Silver, and the Recent Selloff
Gold traders got spooked by tough talk from the Fed. Gold now has strong support around $4,000 and is getting ready for another big rally. In the last 36 hours, about $900 billion was wiped out from gold and silver. Gold fell 2.4%, erasing roughly $680 billion. Silver dropped about 5.5%, wiping out another $190 billion.
You cannot judge the drop in gold and silver without looking at the huge gain that came first. Even after falling, gold stayed above $4,000 an ounce. A few months ago that was a very high price. The fact that gold is not at $5,500 matters far less than the fact that it is at $4,000. Silver is at $57 and change, down from a peak of $120. For years silver traded around $20, sometimes reaching $30 before falling back. All that overhead resistance has now been cleared, and silver is set up for another big bull market, even after a correction in its first breakout.
Some investors felt let down by how gold reacted to the war, but they forgot gold rose before the war started. Part of that earlier rally may have priced in the war itself, making it a "buy the rumor, sell the fact" move. Short-term price swings cause panic exactly when the long-term trend stays intact. The right move is to buy the pullbacks.
The Fed's Empty Tough Talk
There is a "new sheriff in town" who says he will be tough on inflation unlike those before him. That is just talk, an attempt to buy cheap credibility on inflation. Asked in a Senate hearing what he would do to bring inflation down, he gave three policies that all amounted to talking about it and doing nothing. The Fed can only talk. The markets will figure this out, and gold will hit new record highs, if not this year then next. Silver likely too.
On a possible rate hike: odds of a 25 basis point hike had risen to about 35% for the first time after the inflation data came out. But a hike is unlikely. It is a coin toss, yet the Fed will probably stay put. It can hide behind numbers hinting that inflation slowed a bit or the economy weakened, and behind task forces it created to study the problems and suggest solutions, saying it is waiting for their recommendations.
If the Fed does not move at this meeting, the odds of moving at the next meeting are even lower, because the election will be closer and the Fed does not want to spook the markets. If it hikes before the election, it has to do it now. Even if it does, 25 basis points changes nothing. If the Fed truly thinks rates are too low, a quarter point does not fix it.
Rates Are Too Low, But Debt Makes Them Unpayable
Rates should be much higher given how much debt exists and how much inflation is coming. The problem is the country cannot afford to pay rates as high as they need to be. That is why the Fed has been holding them down on purpose. That suppression has bad side effects: a rising cost of living and misallocation of resources.
Every rate hike makes it harder for the US government, which has been rolling over more of its debt short-term. Instead of borrowing for 10 or 30 years, it borrows for a year or less. Over the next 12 months, around $8 trillion of Treasuries must be rolled over. The average coupon on the 10-year is around 2.3%, the 2-year around 4.3%, so refinancing at today's rates is a huge burden.
It is already happening. Annualized net interest expense in June for the US government hit $1.6 trillion. That figure equals the entire federal budget as recently as 1997. Now that much goes to interest alone, before everything else. There is a limit to how much the market can bear, but rates are still far too low.
China, Gold, and the Dollar's Future
China building up gold reserves has become a hot topic in recent weeks. Estimates of how much gold China owns vary widely, with some saying up to 30,000 tons. China is preparing by linking gold to its own currency, the yuan. China probably holds far more gold than it admits and wants to buy far more than it lets on. It understands the dollar's days are numbered and wants to take the dominant position, with the dominant economy and dominant currency. The way to do that is to hold the most gold and back a currency with something real, giving a true alternative to the dollar, which is backed by nothing.
The dollar used to be defined as a weight of gold. Now it is just paper. The US economy does not support the dollar's value because of weak productivity. China's economy does. China has the savings and production the US used to have. China is a major producer, a major manufacturer, and the second largest creditor nation behind Germany, soon to be number one. The Chinese economy will dominate the 21st century, just as America dominated the 20th.
New gold infrastructure may matter more than headline reserve totals. This includes SGE (Shanghai Gold Exchange) vaults in Shanghai and Saudi Arabia, with possible plans in Switzerland and other countries, plus convertibility between gold, the yuan, and even commodities. There has been talk of Saudi oil being paid for in gold-backed yuan. This is a viable set of rails for international trade, but built around China. Institutions build the financial plumbing before capital flows speed up.
Oil, Commodities, and Stagflation
Demand for energy will keep rising, driven by AI and other factors. The real catalyst for much higher oil would be a breakdown in the US dollar against other fiat currencies, which has not happened yet. Against gold, the dollar has already broken down, though it bounced from its lows earlier this year.
When the dollar falls against other paper currencies, oil in dollar terms will rise sharply. If the dollar drops but oil stays the same, that is a price cut for everyone else, so the world will buy more, pushing the dollar price up.
Global stagflation, especially in Western economies, will define the next several years. There has been underinvestment in capacity for all sorts of raw materials, so commodity prices are headed much higher. Add the flood of money created by central banks, especially after COVID when they kicked it into higher gear, and inflationary forces built into the system are now surfacing. Rising demand meets inadequate supply in many commodities. The result is much higher prices, higher interest rates, more expensive commodities, and possibly recession and bear markets in stocks. This resembles the inflation last seen in the 1970s.
No Price Ceiling for Gold
There is no price target for gold or silver, because they have no ceilings, since the dollar has no floor. The dollar could lose all its value, in which case gold and silver prices would be infinite when measured in something worthless. The only target is "higher." You will need more and more dollars to buy the same amount of gold or silver.
If you want to save now to spend or invest later, do not hold dollars. Hold gold or silver instead. The same applies to other fiat currencies, including the euro. Confidence speeches do not protect purchasing power when policy fails to match the words.
Mining Stocks
An audience question asked how the energy supply squeeze will hit miners, since energy is a big cost that raises output cost. The impact will be limited. Energy is a major cost for mining stocks, but they did not gain much from the earlier drop in oil relative to gold, so oil backing up a bit will not be the main driver. Earnings of gold miners will stay very strong, keep beating estimates, and grow. The stocks are undervalued even if higher energy costs trim earnings somewhat.
The recent negative correlation between gold and oil will eventually break down. If oil really starts moving up, gold will move up with it, not down. The long-term trend is for oil and gold to rise together, keeping their ratio intact, despite how they have traded lately.
