Inflation, Global Activity And Gold!

Week Ending, 5th April, 2024

Plenty of newsflow this week:

US: Following last week’s US February PCE (Personal Consumption Expenditure) inflation print (the Fed’s favourite indicator as it more closely defines household inflation) rising a modest +0.26% m/m to 2.78% y/y, a quick scan of its underlying components shows 47% of the core services categories increased by at least 4% y/y over the past six months (that’s an increase on January’s 31%). Concerningly, the energy price pass-through increased to 138% of the pre-pandemic level while industrial metal price pass-through increased to 131% of its pre-pandemic level. This is totally in line with the recent gains in energy price inflation and will keep adding pressure to inflation. While overall inflation numbers were roughly in line with expectations, what was striking was something Powell said in an interview he gave at a San Francisco Fed event: “he doesn't expect the Fed Funds rate to get back to pre-pandemic levels”. For reference, in 2019, the Fed Funds rate was 2.5%......this should be thought of as a floor. We are not heading back to 0%! No surprise therefore that bonds have taken a hit.

So, onto today’s much-awaited US March employment data: it was another good one and compounded woes for bond bulls. Yields rose sharply (i.e. the price of US government bonds fell sharply) across the yield curve spectrum. The details are given below in the “Friday” section but job gains registered +303,000, far more than the forecast +200,000 figure. Wages continue to rise by over 4% y/y. By now, the following points should be apparent:

• The job market remains very solid – in fact, it is being helped by people re-entering the market (as evident by the labour participation rate which rose this time round) as well as boosted by immigration.
• Excessive reliance on the “Job Openings” part of the JOLTS report (Job Openings and Labour Turnover Survey) is highly misleading! The relatively small decline witnessed in total Job Openings over the last few months is a clear indication companies are now focusing their attention (time and money) on retaining existing workers and less so on advertising via Job Openings.
• The wage increases being offered to existing vs new hires is wide-ranging. For job-stayers, wages were unchanged at 5.1% but, for job-changers, it rises dramatically to +10%. The latter is reflected in the monthly employment numbers.

Global Activity: March witnessed a further pickup in global activity. Manufacturing rose +0.3% to 50.6 (expansion territory) while services notched up +0.1% to 52.5 (also expansion territory). Anything over 50 = expansion. Importantly, the global, forward-looking activity components rose for manufacturing (ratio of orders-to-inventories rose +0.02) and for services (services future activity rose +1.6%). For all the doom and gloom associated with and surrounding China, the latter too is back into expansion territory witnessing a rise of +1.0% to 51.1. The Euro-area however witnessed a surprise decline of -0.4% to 46.1%. By contrast, services growth remains robust: in China it rose +0.8% to 52.5 and +1.3% in the Euro-area. The US saw a decline of -0.9% but remains in overall expansion (51.5).

Global activity is picking up as evident by labour and trade data….and it is having a mixed impact on pricing at both an input level as well as output level for both goods manufacturing and services. Inflation-related components show manufacturers’ delivery times shortening (i.e. improving) as Red Sea attacks fade. Manufacturing input (raw materials) prices declining by some -0.5% while output prices declined -0.3%. Against this, services input prices rose +1.1% and output prices rose +0.5%. These types of fluctuations are giving central bankers headaches. To compound matters, there has been a surge in energy prices (Oil and Natural Gas) which is feeding its way through the system. To cap it all, consumers are not giving up on their spending habits making the likes of the Fed wonder when – indeed if at all – to cut rates!

A further indication that world conditions are picking up was to be seen in the latest German industrial orders print released Friday. While it rose more slowly than expected (new orders rose +0.2% m/m but was skewed to a few but big orders otherwise, absent these, it would have fallen by -0.8% m/m), interestingly domestic industrial orders rose +1.5% m/m while foreign industrial orders fell -0.7% m/m. When breaking down the foreign orders further, it was new orders from the EZ that caused the drag falling -13.1% m/m while non-EZ orders rose +7.8% m/m. This ties in with the drop in the Euro-area manufacturing data referenced earlier!

What about the Gold rally?‍

Analysts are revising, upwards, their gold price projections. Are they right to be doing so? Consider the following factors at play here:

• Geopolitical risk is on the rise. At the very least, it certainly hasn’t gone away! Just when everyone thought the Israel-Gaza situation was abating, it has stepped again with the attack on the Iranian embassy in Syria resulting in the death of a top Revolutionary Guard leader. Russia-Ukraine is kicking off again. All this gives gold both risk on and risk off qualities. That’s something Bitcoin cannot compete with.
• The “free-float” equivalent (i.e. the amount of gold available to buy/sell) is not huge given the level of stocking and hoarding, primarily by central banks. This is something that Bitcoin can compete with given the mystique that has been created around having a cap on just 21mn bitcoins (the “bitcoin halving” phenomenon).
• Key components of inflation are on the rise – and this is a spur for gold. It’s not just energy – food is rising too. The latest FAO monthly release for March speaks to this. The March food price index rebounded from a 3-year low reaching 118.3 (Feb: 117.0). The Vegetable oil price index jumped +8% m/m, the dairy price index rose +2.9% m/m while the meat price index rose +1.7% m/m. The cereals and sugar price indices both fell (-2.6% m/m and -5.4% m/m respectively) but weren’t enough to outweigh the gainers. Additionally, as global activity picks up and manufacturing catches up with services, input prices (i.e. inflation will rise).
• As Global activity (referenced above) picks up, demand for gold in industrial use will rise.
• While interest rates remain in a holding formation, that keeps gold in play. Better still, if they fall, that’s a real bonus as it narrows the opportunity cost of holding a non-incoming bearing asset (which is what gold is). If rates remain unchanged, that leaves the field open for gold to benefit from all the factors just mentioned above. The forward curve for Gold is showing $2,600 per troy ounce. The spot price right now is $2,346.80. Furthermore, the collapse in inventory of Gold (due to central banks and other hoarders) is putting derivative structures at risk as traders run a huge risk of not being able to cover short positions. If there is a massive short squeeze in a very low liquid market, the spot price can tear through the $2,600 forward curve level in no time.

MARKET SUMMARY