Interest Rates Rose, But Overall Result Is Bullish For Junior Gold Miners

Source: Investing.com

While Powell’s monetary missteps have been on display for 24+ months, he continues to repeat the same blunders. However, with the old Wall Street adage of ‘take what the market gives you’ proving prescient on Jul. 27, we don’t mind being long the GDXJ ETF and profiting from the short-term sugar high. Therefore, we expect the junior miners’ uprising to continue in the days ahead.

In contrast, with Powell’s preference for patience poised to prove extremely costly over the medium term, we’ll be careful not to overstay our welcome.

While Powell’s dovish rhetoric was met with applause on Jul. 27, his willingness to push up asset prices and loosen financial conditions is like offering needles to drug addicts. In a nutshell: he provides what they want, not what they need. Therefore, while sentiment moves markets and the current environment is bullish for the GDXJ ETF, the medium-term consequences should be dire.

For example, I’ve noted how billionaire hedge fund manager Bill Ackman aligns with our way of thinking about inflation. However, with our view in the extreme minority, the consensus sees things overwhelmingly differently. Moreover, Ackman was spot on when he wrote on Jul. 26 that “the biggest risk to the U.S. economy is not the Fed raising rates. It is inflation.”

Furthermore, while he referenced the sharp drop in U.S. Treasury yields, the drop in investment grade and high yield credit spreads, and the rise in stock prices, (add the USD Index decline, though Ackman didn’t mention that), he noted prior to the FOMC release on Jul. 27 that “financial conditions have eased materially, which has made the inflation problem worse.”

He added:

“What I don’t understand is why Powell is reluctant to say that the Fed will stop inflation in its tracks by raising rates and keeping them as high as they need to be for as long as they need to be until we have durable evidence (not a few months of lower inflation) that inflation has been licked. That is what it is going to take to kill off inflation and preserve the economy and the equity markets for the long term.”

Thus, while Ackman should know that Powell always leans dovish during his press conferences, the six-to-12-month assessment should prove prescient. However, since opponents of the thesis believe that “the market is smarter,” the consensus (for some reason) opines that rampant inflation is preferable to a rate-hike-induced recession.

However, I warned on May 20 that investors should be careful what they wish for. I wrote:

With the consensus still fighting the hawkish realities that I warned about since 2021, the VIX is behaving as you might expect. I mean, why panic when the Fed is all bark and no bite? Therefore, everyone can relax because the Fed will turn dovish, inflation will rage, and in some alternative reality, this outcome is bullish for risk assets.

However, I’ve warned on numerous occasions that a dovish pivot would have dire long-term consequences for the U.S. economy. As such, Fed officials (should) know this, and a small short-term recession is much more attractive than a long-term hyperinflationary collapse. Yet, investors still assume that the latter option is more likely because the Fed can’t withstand falling stock prices.

However, with recency bias clouding investors’ judgment, they don’t realize that 1970s/1980s-like inflation is a completely different animal.

Thus, while the consensus follows the post-GFC ‘bad news is good news’ script and assumes that weak data will elicit a Fed pivot that solves all of the U.S.’s economic problems, the reality is that the recession train has already left the station.

As a result, the choice is between a rate-hike-induced downturn that quells inflation or a hyperinflationary malaise that leaves Americans in a worse position 12 months from now. Likewise, if investors assume that cutting rates or reigniting QE amid rampant inflation will have a positive outcome, they haven’t done their homework. As evidence, I warned on May 26 that the consensus is betting on an outcome that hasn’t materialized in 70+ years. I wrote:

With annualized inflation at [9%+], calming the price pressures with such little action is completely unrealistic. In fact, it’s never happened.

If you analyze the chart below, you can see that the U.S. federal funds rate (the green line) always rises above the year-over-year (YoY) percentage change in the headline Consumer Price Index (the red line) to curb inflation. Therefore, investors are kidding themselves if they think the Fed is about to re-write history.

In addition, notice how every inflation spike leads to a higher U.S. federal funds rate and then a recession (the vertical gray bars)? As such, do you really think this time is different?