Inflation upended the bond market once again, and the bearish weight was too much for the white metal.
While the crowd remains fixated on inflation, we’ve moved on from that fundamental thesis. In 2021, when the consensus assumed inflation was transitory, we warned it would strike with a vengeance. And now, while the consensus assumes that long-term interest rates can rise indefinitely without any economic scarring, we’re fading that narrative, too. As it stands, silver’s next major slide could occur alongside lower, not higher, interest rates.
As evidence, the NFIB released its Small Business Optimism Index on Oct. 12. And with the headline metric declining from 91.3 in August to 90.8 in September, early signs of demand destruction are present. NFIB Chief Economist Bill Dunkelberg said:
“Owners remain pessimistic about future business conditions, which has contributed to the low optimism they have regarding the economy. Sales growth among small businesses have slowed and the bottom line is being squeezed, leaving owners few options beyond raising selling prices for financial relief.”
Thus, while we warned on numerous occasions that higher long-term interest rates are a much different animal than a higher FFR, 2023’s fundamentals contrast 2021 and 2022.
Please see below:
To explain, we faded the recession narratives in 2021 and 2022 because (in part) NFIB respondents’ ‘single most important problems’ were inflation and the cost of labor, while poor sales were non-existent.
But, that relationship has flipped. Fewer participants are worried about output and wage inflation than in September 2022, while more are worried about poor sales. Furthermore, the divergence should only worsen with long-term interest rates increasing, and a potential recession is bearish for gold.
To that point, the recent spike in long-term rates has made it more difficult for Americans to obtain credit. The New York Fed’s latest Survey of Consumer Expenditures (SCE) showed that the percentage of respondents claiming it’s much harder to borrow money now than a year ago hit a survey high (the blue line below).
Please see below:
Credit Concerns
While ominous metrics are noticeable beneath the surface, the crowd continues to assume that little economic damage lies ahead. And with the crude oil price still relatively uplifted, demand destruction is considered a low-probability event. However, with delinquency rates rising dramatically across riskier lenders, higher interest rates should only exacerbate the problem.
Please see below:
To explain, the delinquency rate on credit card loans issued by banks outside of the top 100 hit an all-time high dating back to 1991. Moreover, smaller banks often make loans to less creditworthy borrowers, which highlights the stress that should continue as the economy weakens. And if (when) market volatility strikes, it should boost the USD Index.
Finally, while interest rates are the main problem, it’s essential not to overlook the effects of quantitative tightening (QT). While the policy has become an afterthought, global central banks continue to drain liquidity from the system, and the development should have profound consequences in 2024.
Please see below:
To explain, the various bars above highlight the increases and decreases in G10 central banks’ balance sheets. If you analyze the right side of the chart, you can see that a sustained drawdown is present. Moreover, the drought should continue until inflation magically disappears or a recession unfolds. And if history is any indication, the latter is much more likely than the former.
Overall, the fundamental landscape remains aligned with our expectations. Recessions occur due to the cumulative effect of various cuts, similar to chopping down a tree with an axe. And if (when) a crash eventually occurs, the S&P 500 should come under heavy pressure, and silver and mining stocks should experience significant drawdowns.
To stay prepared, subscribe to our premium Gold Trading Alert. We’ve booked 11 profitable trades in a row, and the technicals have been the main driver of our success. Consequently, while the fundamentals presented in this report are instrumental, knowing where and when to enter and exit positions are paramount to protecting profits and managing risk. Likewise, we see plenty of potential profitable opportunities on the horizon.
Alex Demolitor
Precious Metals Strategist