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Inflation Threatens While Risks in Stocks & Treasuries Rise
Greg Weldon: Stock Market "As Overextended as Anything I’ve Ever Seen"
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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.
Coming up later in today’s program we’ll hear a tremendous interview with Greg Weldon of Weldon Financial. Greg lays out a compelling case for higher inflation later this year, the dominoes it will cause to fall, and how it will affect the average consumer, Fed policy, the stock market and precious metals. Don’t miss my conversation with Greg Weldon, coming up after this week’s market update.
The gold market tested the $1,300 level this week as dollar strength exerted additional downward pressure on metals prices. Gold bulls did manage to successfully defend the $1,300 key support level mid week.
As of this Friday recording, gold prices come in at $1,312, down 0.9% on the week. Silver, meanwhile, is posting a 0.4% weekly decline to bring spot prices to $16.48 an ounce.
Precious metals markets rallied modestly following the Federal Reserve’s policy meeting on Wednesday. Fed officials opted to leave their benchmark interest rate unchanged while reiterating that they remain on course to gradually hike rates. Odds currently favor a rate hike at the next FOMC meeting in June.
It’s been one of the most gradual and drawn out rate raising campaigns in history. It started in December 2015, which also happens to mark the bottom for gold and silver prices. Their upward moves since then have also been gradual. The persistent sideways trading range going on several months now has many metals investors frustrated and some wondering whether the Fed is putting a lid on prices.
The range bound gold market represents a sort of stalemate between interest rates and inflation. Rising real interest rates tend to be negative for gold, while rising inflation expectations tend to stimulate buying. The question that has yet to be resolved is whether the Fed’s gradual rate hikes will put a damper on inflation or whether the central bank is behind the curve.
For whatever the opinion of the anointed ones is worth, Fed policymakers expect official inflation to run at close to 2% over the next 12 months. The key word in the Federal Open Market Committee’s statement Wednesday was “symmetric” – as in the Fed holds to a symmetric 2% inflation target. That has been interpreted by Fed watchers to mean the rate-setting body is willing to allow inflation to exceed 2% over an extended period to offset recent periods of sub-2% inflation.
Recent Consumer Price Index and Personal Consumption Expenditures data confirm that inflation as measured by the Fed’s own gauges is now running at 2%.
The risk is that in inviting inflation to rise above 2%, monetary planners will have difficulty containing upward momentum in price levels. Stocks and bonds are currently priced for very low inflation for decades to come. Investors who hold only paper assets in their portfolio have little margin for error.
Long-term Treasury bond yields recently hit 3%, giving bondholders a slightly positive real return assuming 2% inflation. That’s a risky assumption to make for the next 10 years, 20 years, or even 30 years ahead.
Fed officials want us to believe that inflation will be symmetric around 2%. In reality, inflation risk is asymmetric under a fiat monetary system. There is virtually no chance of inflation moving several points to the downside in a deep deflation. The Fed simply wouldn’t tolerate rapidly falling prices and would act to prevent such an outcome by any means necessary.
But the Fed has a history of getting behind the curve on inflation and chasing it higher with rate hikes. There may even come a time when it decides to raise its inflation target in order to more rapidly erode the real value of insurmountable government debt obligations. In such an event bondholders would get totally screwed.
The risk/reward potential for U.S. Treasuries is asymmetric – limited reward versus the risk of near total loss in a worst-case scenario. The risk/reward potential for precious metals is also asymmetric. Since gold and silver can’t default or go to zero, downside risk is limited, especially at these relatively cheap prices. The upside potential for precious metals is multiples of where they currently trade in both nominal and real terms.
Don’t expect those kinds of gains to begin accruing right away. But do expect to eventually be rewarded for buying low and sitting tight.
Well now, for more on the growing inflation story and to find out what our guest has to say about the risk/reward potential for gold, let’s get right to this week’s exclusive interview.
Mike Gleason: It is my privilege now to welcome in Greg Weldon, CEO and President of Weldon Financial. Greg has over three decades of market research and trading experiencing, specializing in the metals and commodity markets and even authored a book in 2006 titled, Gold Trading Boot Camp where he accurately predicted the implosion of the U.S. credit market and urged people to buy gold when it was only $550 an ounce. He's a highly sought-after presenter at financial conferences throughout the country and is a regular guest on many popular financial shows, and it's great to have him back here on the Money Metals Podcast.
Greg, good to talk to you again today and thanks for coming on.
Greg Weldon: Thanks, Mike. My pleasure.
Mike Gleason: When we spoke to you last back in February, Greg, we talked about the U.S. dollar. It had been sliding for more than a year and looked weak. Since early April, however, the greenback has been rallying hard. The move has been weighing on gold and silver prices over the past couple of weeks. What is your take on the dollar's recent move higher? What's driving it? Do you think it has further to climb or is this a bit of a sucker's rally?
Greg Weldon: Well, how about all of the above? I think that it's a corrective move first of all. I see an upside push maybe towards 96 would be kind of a target for a rally here in the dollar. I think the secular pressure on the dollar remains in full force, and that is Twin Towers deficits particularly the deepening U.S. budget deficit, how that links into first of all the tax cuts of course, but really more significantly, the rise in interest cost. So you're kind of in this cycle here where higher interest costs beget higher debt which begets deeper deficits which begets higher interest costs, so on and so forth.
I think longer term by the end of the year we're probably looking at a lower dollar, but having said that I think last week gave us a really good kind of example as to why the dollar has pushed higher here, and it really kind of only broke out in the last few days. And I think that's on the back of the downside reversal you have going on in some of the European bond markets after Mario Draghi's press conference last Thursday. I thought it was very interesting the comments that he made, particularly about, "We don't see signs of sustained inflation. We see a moderating in the economy. That moderating is sharp, it's broad, although we believe it's temporary."
So, the thought process had been that maybe the ECB, once the end of September came and the QE kind of taper, ran down that they might actually tap out from QE. And as a preparation for raising interest rates next year, something that is still priced into the futures market in the Euro Board deposit rate futures, but less so than it had been. And I think the key here of course is inflation. I think inflation is going to be rising throughout the rest of the year. We talked about this earlier in the year, the end of last year in our January year ahead piece and we targeted the May to June period for this to start to really show up in the data. And I think we're going to see that in terms of energy prices.
And then the wild card, which is the Ag markets and food prices, which we see on the rise as well, particularly as it relates to the U.S. grain crops and some of the stuff that we can talk about maybe in a minute. But I think that in that context, thinking that European bond yields are going to break down further from here seems unrealistic unless in fact the ECB is going to re expand QE, something that Mario Draghi floated on Thursday. So I think that really caught the market by surprise. It really hurt the euro, boosted the dollar, but I think to suggest that the German two-year can get back below -60 basis points at a time when German GDP growth is three percent, and German inflation is 1.6 and likely to rise. I mean, not only is it a negative 60 basis point two-year in Germany, think about the real yields you're talking about here. They're so deeply negative.
We saw the same thing in the U.S. really in September when then chair Janet Yellen suggested they wanted to not normalize rates, but go to neutral, which meant to lift the bond market, particularly in the short end, which was wildly overpriced because of QE to the level of inflation. And that's what we've seen in the two-year note. It went from 140 when she made these comments in September of last year to where it is now at 250, which is a new high. So, in the context of the rising ECI, the rising wages in the U.S. ... and let's not forget, and one point I'll make without making this answer too long ... If you look at the U.S. Employment Report from last month, all the talk was about hourly earnings being subdued and not rising. The fact of the matter is a lot of the Fed reports show us, tell us very clearly that firms looking for skilled workers, having difficulty finding skilled workers, are now extending the hours of their current workers. So, if you're not making more per hour, but you're working longer hours, you're still making more money.
So the weekly earnings from the Employment Report were at 3.3. You got import prices of 3.6, and now you got from the ECI private sector wages are around 3. So you see some movement here in the U.S. that boosts the two-year to two and a half, at the same time the German two-year is falling and thus the yield differentials kind of come back into vogue as a driving force in the dollar. But I think that the decline in European bond yields will be short-lived and I think you'll see a reemergence of an upside push, particularly in Germany. And that's probably something that will add to pressure on the dollar later in the year along with a continued deficit widening story.
Mike Gleason: Greg, those of us who question whether or not the Fed can get away with raising rates, look at the months ahead as sort of a moment of truth if "normalizing" interest rates means that treasury yields are headed back to four to five percent. You've got to think that it will just crush the federal budget and the U.S. economy, which is addicted to ultra-low rates as we all know will in our view have to endure some painful withdrawal symptoms. And now on the one hand, the Fed has hiked rates several times seemingly without major repercussions. On the other, volatility is creeping back into the equity markets and the indexes have fallen since their highs in late January. Mortgage rates have moved higher. So we're very curious about how this will play out and wanted to get your thoughts. Is the Fed going to be able to stay the course and double the Fed funds rate over the next 24 months here, Greg? Or are the markets and the economy at large going to rebel and force officials at the Fed to abandon their plans for tightening?
Greg Weldon: I mean that's the real big 64 million dollar question here, Mike. No doubt about it. And I think the answer lies in the path of inflation. And I think the Fed could find themselves in a very difficult situation second half of the year if you get inflation up above three percent, which is certainly not out of the question. Again, a big component of this is the commodities markets, energy and food and agricultural products in particular. I don't know that I would anticipate a doubling of the Fed funds, and I think the word normalization to me is something that is kind of a ... I don't even know why people use that because what's normal? Normal for right now is what we have right now. So I love the term neutral because if you want a neutral policy rate, that essentially means you don't have negative real yields.
So, if inflation rises above three percent, which I think is a very good chance it could, wages continue to rise, import prices are a big deal, particularly if you get any kind of additional trade friction specifically with China because U.S. consumer goods imports from China are significant. They've been negative in terms of the year-over-year price dynamic for the last three years and have just moved into positive territory. If you start talking tariffs, you start lifting import prices from China, that's going to put further upside pressure on inflation. So to me it becomes a question of where is neutral?
And I think this is kind of what the bond market is doing now. It's reacting to neutral maybe had been two percent back in September, but maybe now neutral is two and a half, two seventy-five, could be as high as three already and if that does push higher, that's going to put a lot of pressure on the Fed to keep pace with inflation potentially at the expense of the U.S. consumer.
And this is really the tipping point. Where does the U.S. consumer kind of fall off the cliff here? And I call it a cliff because you're talking about a consumer that is highly leveraged here. When I hear in the pop media that the consumer is healthy, I don't what these people that are saying that what they're looking at because the credit numbers on the Fed, the credit numbers from the banks, the auto loan situation, while certainly not as big as subprime in 2007, it's still significant. All of these factors play into a consumer that has gone on a borrowing binge and really traces back to precisely when the Fed stopped buying bonds and the stock market continued to rise on really Trump's election and what's viewed as fiscal QE, which is much different than monetary QE. And as a result of that, we got, I think it's 39 out of the last 40 months, the year-over-year growth in U.S. consumer credit is above $200 billon. That's unprecedented, I mean, not even close to anything we've ever seen before. That borrowing is essentially the collateral is rising stock market.
So, it is a similar situation now as it was in 2006 and 2007 in that consumers are borrowing money against a paper asset and unrealized profits that may or may not ultimately be there. So, I think a lot of it hinges on the stock market, how the consumer plays out and what's the Fed’s going to do if inflation's rising and the consumer is struggling. And let me tell you, what's interesting to me is if you look at the debt payments of consumers, on a nominal dollar basis, they're near their highs even though interest rates are still pretty low relatively speaking.
If interest rates continue to move up here, not only does it put pressure on the U.S. budget deficit, it puts pressure on the consumer. And if wage growth doesn't keep pace and it's not, that's a real problem. So, I don't know where that tipping point is. I think we'll see it coming when we get there. But I think that's where we're headed. We're headed to some kind of a crisis, maybe that’s too strong a word but maybe it's not, as it relates to the Fed policy. How do you deal with inflation without crushing the consumer, and that may be something that's just not possible.
Mike Gleason: Obviously, the dollar pulling back again would certainly help with gold and silver one would think, but aside from that which we've already touched on a bit, what catalyst or catalysts do you see ahead that could potentially give metals the long-awaited boost that they've been looking for to break out of this range trade, Greg?
Greg Weldon: I think it is the dollar, and I think it's a question of being patient and timing and maybe having to withstand a little more pain. What I will point out is that the dollar is breaking out to the upside a lot more than gold is breaking to the downside. So, I think there are some hints here that you could see a period of time, and maybe it's towards the end of a dollar correction… maybe if you get above $94.50 in the dollar index and headed towards $96, maybe in that interim between those two price points… you could start to see gold kind of diverge from the dollar, meaning it's not as negatively correlated as it might otherwise be.
The other thing I would say, a breakdown in stocks could be interesting for gold. It's not the same situation we had in 2008, where people were really long gold and the stock market cracked and they sold their gold to raise liquidity. You don't have the length in the gold market now like you did then. So I think you have some insulation in gold and silver from a decline in the stock market to where it could actually cause a rotation of capital and be bullish.
Right now the technicals in gold and silver look a little sloppy, but that's a dollar story and I don't think the dollar story is a sustainable story throughout the rest of the year. So, I think anywhere here, you're between $1,250 and $1,300 in gold, that's probably from a longer-term perspective a really good value.
Mike Gleason: Yeah, that's a really good point comparing and contrasting the situation today versus 2008 in terms of where people were positioned in the gold market. I'm glad you brought that up.
As a follow-up to that in your experience, Greg, as a long time trader and technical analyst who follows the commodities and precious metals like few do, I wanted to have you share your thoughts about the silver market specifically here, given the sideways grinding type of action we've seen for months and months now where we seem to be stuck in a pretty narrow trading range between say $16 or so on the bottom and $17.50 or $18.00 on the top.
Just from a technical perspective and taking a longer term view of the silver market, do you expect this phase that we've been in serving as a constructive base-building type of situation that makes the support on the charts more and more solid here the longer we go? And might we look back in a few years from now and say that this months’ long consolidation period in silver proved to be the impetus for a launching off point for a big move higher of ... basically in your experience when you see a longer term range trade type of market in a particular commodity or a precious metal, does that usually foretell a positive or negative next step once it finally breaks out of its range?
Greg Weldon: Real quick answer to that is yes, positive. When you look at kind of the real secular, longer term technical positioning of both gold and silver ... and let me just preface this by saying I think part of the reason that silver's underperforming is because people have gotten burned in silver. I mean, if you bought silver in any of the breakouts in the last year and a half or so, you haven't done well. And the second it seems to break out is the second it gets pummeled. So, I think that silver is kind of a wait and see mode, it's more of a speculative metal to begin with. It's not as heavily traded so it's subject to some more violent whipsaws than you might see in gold. But if gold gets above this critical upside pivot at $1,377, I think you'll see silver take off. And I think the long-term pattern is very much of they still think it's $16 and a breakout above $17.50, that would be quite bullish from a longer term perspective.
Mike Gleason: Well, as we begin to close here, Greg, any final comments on what you're watching most closely here as we move into the middle part of the year with the summer months right around the corner? Any thoughts on what investors should be watching most closely, what you're watching most closely. And are we nearing a key inflection point in the economy? You alluded to that the last time we spoke. Do you envision the Trump rally finally fizzling out in any sort of major way? Basically what are we going to be evaluating and looking for in these markets over the short to medium term?
Greg Weldon: Well you ask, what am I most closely watching, and I'll respond by saying, "Do you have an hour?" Because you have to watch everything. So quickly, I think really key is the German two-year Schatz Yield. No doubt about that at a -60 basis point level relative to GDP and inflation in Germany, that's just unsustainable, and when you think about the pop you saw in the U.S. two-year, that might look like child's play once the German bond market gets on a roll to the downside in price and the upside in yield. So that's number one.
Number two, clearly the U.S. stock market. I think it's highly vulnerable here. I think it's heavily invested. Where is the next big impetus for growth coming? You've had some good earnings report, which has helped hold up the market here, but I think really kind of the secular fundamental picture is of a market that remains as overextended as anything I've ever seen. Despite the correction you've had. And despite the correction you've had, you have not seen the market pop back to the upside like it might normally on kind of this “buy the dip into the 200-day moving average in the S&P” philosophy goes. So you don't have that pattern kind of repeating itself, which I think the longer you're not seeing a renewed rally in the stock market, the more vulnerable it is. And that may sound simple but I think it's really compelling in terms of what to watch.
And really to me if inflation is the key, then energy and commodities are the key and I specifically have been focused this year to the point where we launched a new Managed Accounts Program specifically in the commodity sector with a heavy weighting in the Ag sector because the Ag markets to me are about as exciting as I've seen them in a long time, and certainly since 2011 and maybe even longer.
You look at the situation from the supply/demand fundamentals, and this is a market that has been heavily oversupplied in the last two to three years, has had big price declines in corn, wheat, soybeans, so on and so forth. Those price declines I think are over. I think that the supply/demand fundamentals have shifted from a bearish to a potentially very bullish situation as it relates to the oil seed for example you had the situation in South America. We had a big drought. The soybean crop there is still not completely tallied, but you're looking at a 12 to 14 percent decline. They're the world's larger exporter of soybean meal, which is in huge demand around the world. So, the U.S. crop is critical to this because you have no margin for error. If you get any kind of weather event in the U.S. in the growing season here as it relates to the crops, these markets could be explosive. Given the position relative to a year ago when these markets were virtually crashing throughout the summer on huge crops, and we say huge crops, and it's not necessarily bearish to see huge crops if demand is equally huge.
And that's what's happened here particularly in the soybean market. You've had the huge crops but you haven't seen ... I mean the market's still nine dollars at its low. That's pretty high on a historical basis because demand is growing almost as fast as supply had been growing and is now growing faster. So, if you get any kind of weather event in the U.S. which crimps demand from the U.S., you have a real serious situation in the soybean market. And the numbers released by the USDA on Monday show you are way behind corn in terms of its emergence as a crop here. Really far behind.
The winter wheat crop is in much worse condition than it was a year ago or the five-year average for this time of year. And the planting of spring wheat is also way behind. So, when you have no margin for error on your supply/demand fundamentals, and you're this far behind in the development or planting of the crop, that spells opportunity to me going forward. So, we really like the grain markets, for your listeners the JJG is the grain ETF that we follow that is kind of breaking out there. Corn broke out Monday. Wheat broke out Monday. We like soybean meal a lot. That broke out really two, three months ago.
And that will then impact food prices, which have been dormant. Food prices have actually been negative on a year-over-year basis until just the last three or four months and it's popped to about a 1.4% year-over-year rate, and I think it goes much higher and that will push inflation higher. Not only here in the U.S. but think about this Mike, if you take food inflation, it's a much bigger component of price indexes in places like China and India, where you could have problems on a bigger scale from food price inflation, let alone wage inflation in the U.S. So, I think all these factors really suggest that the Fed could find itself in a box by the end of the year. But my focus here is to take advantage of this for our clients, and right now the grain and oil seed market is a place that we're really focused on as having opportunities this summer.
One more market I might mention in that same vein in the energy space that could have an impact on inflation would be natural gas where you have pretty low prices and you have a big, big decline because of the cold winter here in the U.S., particularly in the Northeast in inventories. You're 29% below a year ago. You're 40% below the five-year average for this time of year in natural gas inventories. You would normally would have started a build, a seasonal build already. That's not yet happening, so I think natural gas, particularly given kind of how low it's priced historically is another commodity that has great potential. It's one of the commodities that we added to this program that we just kicked off here to try and take advantage of some of these moves in commodities which I think will become more intense as the summer progresses.
Mike Gleason: At the beginning of the answer when you talk about how many things you have to watch, if we connect the dots, obviously there could be a lot of dominoes that fall there. We get higher inflation through the rising food costs. Maybe we get a broader commodities rally, precious metals, gold and silver get swept up in that and we could see the whole sector really perform well.
Well Greg, thank you so much for joining us again. We always enjoy having you on and really value you sharing your studied insights and sharing those with our audience. Now before we let you go, please tell folks about Weldon Financial, how they can find you and any other information that they should know about you and your firm.
Greg Weldon: Sure, thanks Mike. Well, it's WeldonOnline.com. We do, what we call it daily research although I don't publish every day because I solely do all of the work around the research. We cover all the sectors of the market pretty consistently. We have a daily report, a short video that comes out every day. It's kind of like a conference presentation every single day. So, your listeners, any of whom have not had a trial, free trial to our service are welcome to come to the website and sign up. And also, in terms of our Managed Accounts Program, we're really excited about the potential opportunity here in the commodities markets.
And if you think about commodities real quickly, I'll just add, that the CRB's breaking out and it's breaking out in a way, and this is part of why I think gold and silver are still going to be okay. You got to go back to the 90's for this pattern where you had a rally from '98, '99 into 2011 high. You had the retracement, which is A-B-C Fibonacci ratio based in the math and now you're breaking out to the upside in the CRB index, which is a more heavily grain / Ag weighted than the GSCI, the Goldman Sachs Index, which is more energy which is already broken out on a long-term basis. So, I think these are emerging secular bull markets in the agricultural commodities, in the commodities as a whole and that links back to gold and silver so that's really where we're excited to have the opportunity. And if you want information on how you might participate in that vis a vis our Managed Accounts Programs, you can email me directly at [email protected].
Mike Gleason: Well good stuff. Thanks again for your time and have a great weekend, Greg and look forward to catching up with you again before long.
Greg Weldon: Sure. My pleasure Mike. Any time.
Mike Gleason: Well, that will do it for this week. Thanks again to Greg Weldon of Weldon Financial and WeldonLive. For more information, simply go to WeldonOnline.com where you can sign up for a free trial. Again, you can find all of that information at WeldonOnline.com. Be sure to check that out.
And check back here next Friday for our next weekly Market Wrap Podcast. Until then, this has been Mike Gleason with Money Metals Exchange, thanks for listening and have a great weekend everybody.