Last week, I talked about the coming changes at the Federal Reserve. New Fed chair Kevin Warsh is going back to the days of secrecy, getting rid of the forward guidance days of the last 15-plus years.
He also wants to change the way the Fed sources and uses data. And how it looks at inflation.
Something I believe is long overdue.
The funny thing is Warsh’s first press conference as Fed chair spooked investors and analysts. After more than a decade of the Fed telegraphing its next move, Fed watchers actually have to do some real thinking.
It’s clear they’re having a hard time with this new reality. So much so, in what I think is one of the worst calls of the year, Bank of America is calling for the Fed to hike interest rates three times this year.
But what does the data actually say?
The most recent official inflation reading from official sources is 4.2%. It’s the highest reading in about three years.
It has many investors fearing the start of runaway inflation. And it’s part of the reason Bank of America made its call.
Except there’s a problem with that. And all we need to do is look at one chart.
When the war in Iran started, the price of oil took off like a rocket. It’s no surprise since the Strait of Hormuz handles about 25% of all oil shipments worldwide. And it had investors predicting the price of oil heading over $200 a barrel.
Except, that didn’t happen. Instead, the world adjusted and when oil started flowing from the region again over the past few weeks, oil went into freefall.
All you need to do is look at that chart again and ask if the price of oil is cratering, will inflation surge?
You probably know the answer. And that’s even with yesterday’s spike after the U.S. responded to Iran firing on civilian ships in the Strait of Hormuz.
But just to relieve any doubt, here’s what inflation expectations look like today.
Inflation numbers lag what’s actually happening in real time. Which is part of the problem. It leads to analysts modeling out the recent trend continuing its same path: upward. But in reality, we know that’s probably not the case.
Which is why I believe a better measure of inflation is the Truflation Index.
It measures the same inputs as the Bureau of Labor Statistics uses to measure inflation. But it updates those figures every day in real-time. Meaning it can better measure what’s actually happening on the ground than a Fed economist that never leaves the office.
What this means is that I don’t believe the Fed will raise rates at all this year, let alone three times. The actual data doesn’t say that it should.
Inflation isn’t the problem. It’s the outdated Fed models that are the problem. Something we know Kevin Warsh wants to change. And something that could eventually lead to a different outcome for interest rates than the consensus view that the Fed is about the raise them.
The next step then is figuring out just how to position for it.
Going for Gold
In general, if we expect that interest rates aren’t going to increase and may in fact head lower, then we should expect the bull market in stocks to keep going. Something I talked about in my prediction series in December. (You can catch up on my predictions here, here, here and here.)
Specifically though, there are some sectors that look primed to outperform. For example, gold and gold stocks.
The fear of rate hikes is part of the reason that the price of gold is off about 5% so far this year. When you have fixed income investments – like Treasuries – that end up paying higher interest rates, it tends to be a better use of cash than parking your money in the gold sector.
And if the Fed hikes rates, bonds will pay even more than they do now.
So it’s no surprise that gold is hovering around the $4,100 per ounce mark right now.
But as I told Founding Members of Strategic Trader in our most recent quarterly Zoom call, I’m looking for gold to start creeping higher. Especially as investors realize the Fed has room not just to keep rates steady, but to lower rates in the coming months.
In fact, readers of Strategic Trader are playing this already with gold-related warrants.
Yet that’s only part of the story. The fact is that right now, gold stocks are some of the most unloved out there. Almost no one wants anything to do with them.
And yet, gold mining companies are the most profitable they’ve been in years, if not in history. Something we can see by looking at the free cash flow (FCF) of gold miners versus the FCF of S&P 500 companies.
In most years, that FCF differential favors S&P 500 companies. But when it flips, it typically means gold mining companies are extremely cheap. And right now, they’re historically cheap.
At some point, investors will recognize this. And I believe the thing that will kick off the next leg higher in the gold trade will be when investors realize they’ve misread Kevin Warsh’s Fed.
At the end of the day, markets – including the gold sector – are reacting to the inflation narrative and potential for Fed rate hikes this year. Now’s the time to position for the opposite to happen. When you look back in the coming months, I bet you’ll be happy that you did.
Regards,
Editor, Strategic Trader