The Rapidly Changing Investment Environment:

Inflation is the most salient issue for businesses, according to the NFIB and ISM surveys, but despite that, Powell and the FOMC are pining for rate cuts and to end Quantitative Tightening. 

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The Fed is discussing several rate cuts this year and planning to reduce the pace of quantitative tightening by half, even though it missed its inflation target of 2% for the past three years. And inflation is advancing further away from that target. CPI rose 3.5% y/y in March vs. 3.2% in February. 
 

But Chair Powell and the FOMC remain unfazed. Our central bank wants to ease monetary policy despite massive asset bubbles in stocks and real estate. According to the WSJ, food prices have increased by 36.5% in the last four years, and mounting inflation has caused 78% of consumers to live paycheck to paycheck. Credit spreads are tight and getting tighter, financial conditions are easy, and commodity prices have soared. 
 

Yet, Powell is still determined to cut rates and reduce the pace of Q.T. Because the Fed cares about banks, not the dollar’s purchasing power and consumers’ living standards. Banks’ assets, primarily Mortgage bonds and Treasuries, are underwater. The Fed hopes to ease the downward pressure on these bond prices by reducing rates. Also, the corporate refinancing wall is now being implemented. $1.8 trillion in corporate debt must be refinanced by the end of 2025. 
 

The commercial real estate market is on life support, and the only thing keeping it from flatlining is the resurgence of the ‘extend and pretend’ strategy, which banks use to extend loan maturities while deferring the recognition of losses. While the practice is not easily quantifiable, it is helping banks manage their nearly $1.1 trillion in commercial mortgage loans requiring refinancing before the end of 2024. As of December 2023, the delinquency rate for office property loan balances had risen, indicating growing financial stress. While this strategy may offer short-term relief, banks can only ”pretend” for so long; therefore, it relies entirely on the Fed lowering interest rates in the near future. 
 

MIDDLE CLASS BEING SQUEEZED

Then we have household debt, which is now $20 trillion, up from $15.6 Trillion in 2019. Consumers have much more revolving credit today than when heading into the global financial crisis. Their holdings of credit card debt, HELOC, and personal loans have led to an aggregate $200 billion loss in income during the Fed’s current tightening cycle. 
 

However, perhaps the most concerning issue is the U.S. government debt service costs, which are set to skyrocket in the next decades at the current interest rates. Interest payments on outstanding publicly traded debt will rise to $1 trillion in 2025. The national debt is soaring along with the cost of financing that debt. According to Bank of America, the U.S. government adds 1 trillion dollars to the national debt every 100 days. According to Market Watch, 7.6 trillion of old debt is getting refinanced over the next year at higher rates. If rates don’t go down soon, the U.S. government will be in a debt spiral, taking on new debt to pay back the interest on old debt. For all these reasons, Mr. Powell needs to reduce borrowing costs quickly. 
 

Therefore, the Fed is running with the narrative that the U.S. economy is strong and that the inflation rate will soon return to the 2% target. But the opposite is the case. Inflation is destroying the middle class, and you cannot have a sustainable economy without a vibrant middle class. Most of the growth in the economic data is just measuring rising inflation. For example, retail sales increased by 0.7% in March, which was considerably faster than the Dow Jones consensus forecast for a 0.3% rise.

Excluding auto-related receipts, retail sales jumped 1.1%, well ahead of the estimate for a 0.5% advance. The core control group, which strips out autos and fuel and is the input to determine the increase in GDP, also increased by 1.1%. Of course, Wall Street and the MSFM rejoiced over the supposedly robust consumer spending. However, they conveniently forget that retail sales are reported in nominal terms, meaning those numbers are not a result of increased sales but increased prices. After all, it is doubtful that the 6% jump in the 19 commodities in the CRB Index during March didn’t translate to a significant increase in consumer prices. Therefore, market prices are screaming that inflation is rising rapidly, much faster than the nominal 1.1% increase in retail sales. Hence, if you wanted to know what consumer spending was doing in real terms, it would most likely have been a negative number. 
 

CENTRAL BANKS STOCKPILING GOLD

However, it is much easier to pretend to have a growing economy than to admit that inflation is running hot and that the government cannot fight it appropriately without throwing the financial system into chaos. The Fed does not control long-term interest rates, and inflation is causing yields to rise —causing more stress in the real estate market. Purchasing a new home is becoming unaffordable for a growing percentage of Americans. It is impossible to have a robust economy when real estate transactions are frozen, and home prices have become so far dislocated from where the free market can support them. 
 

However, If home prices and stock valuations returned to their historical average concerning incomes and GDP, it would require a drop of about 40% from current levels, which would throw the banking system and economy into chaos. 
 

Of course, the bull market in gold (real money) exposes the truth about the economy, inflation, and the U.S. government’s state of insolvency. Why is gold soaring? Of course, there’s the current geopolitical strife, which is particularly acute now. 
 

There is also the continuing tailwind from foreign central banks buying to diversify their currency reserves outside of U.S. dollars and into gold, which is outside the reach of sanctions and confiscations. The truth is many central banks have been stockpiling gold. According to the World Gold Council’s Goldhub data in January 2024, they added 39 tonnes (metric ton) to global gold reserves, with Turkey and China being two big buyers. The Central Bank of Turkey was the largest buyer, increasing its official gold holdings by 12 tonnes. Additionally, the People’s Bank of China saw its gold reserves rise by 10 tonnes, marking the 15th consecutive month of additions. Other central banks, including India, Kazakhstan, Jordan, and the Czech National Bank, also contributed to the net purchases.  
 

But as central banks have been stocking up on gold, the average investor has been selling paper gold, leading ETF’s to see net outflows. According to the World Gold Council, ETFs lost U.S. $469 million in March and $2.8 billion over the last eight months. 
 

However, anecdotal evidence demonstrates that retail investors do have a desire to own physical precious metals. The popular retailer Costco is getting into the gold rush, and its accessibility makes it easier for the average person to add precious metals to their portfolio. You can now purchase gold bars and silver coins as a Costco member. Costco’s venture into precious metals has garnered attention and is offered at a lower cost than most competitors, bringing gold cheaply to the masses. The offering has been so successful that the retailer is persistently running out of stock. 
 

INFLATION AND INTEREST RATES

However, I believe the primary reason consumer demand for gold will increase is the epiphany on the part of investors, as the Fed is losing control of inflation and is now chronically engaged in an interest rate suppression regime. In other words, our central bank will most likely be caught in the trap of being forced to perpetually print trillions of dollars each year--creating more inflation--and purchasing Treasuries to try and prevent interest rates from inexorably spiralling upward. The outcome of this practice will be falling real interest rates, where nominal interest rates rise more slowly than the inflation rate. This is a central bank’s last-ditch effort to try and assuage the government’s insolvent condition. This is the environment in which gold thrives the most. 
 

Of course, this sounds far-fetched to ever happen in the United States of America. But how many people believed 20 years ago that the U.S. would be running multiple trillion-dollar annual deficits, most of which are monetised by the Fed with alacrity? Sadly, Washington D.C. is turning the once mighty U.S. economy into a Banana Republic. The investing environment is changing rapidly. The buy-and-hold portfolio needs a significant overhaul.   EG