One puzzling aspect of the current market is the poor performance of gold
Yet, we've had this precise mix of ideal catalysts for precious metals, but there has been little impact on the gold price. In fact, some could argue that the lack of strength in gold augurs that precious metals investors are thinking that the current spike in inflation is not a structural development.
An alternative theory is that gold is simply no longer an effective inflation hedge. The alternative theory is probably even more disturbing for gold bugs as it undermines a core reason to own it.
Now, we are likely to see conditions deteriorate further for gold and silver as the Federal Reserve continues to ratchet up the pressure to fight inflation. As the September FOMC meeting nears, currently the market has a 90% expectation of a 75 basis point hike and a 10% chance of a 100 basis point hike. The pace of these hikes should continue especially after the August CPI report which showed a broadening out of inflationary pressures rather than a narrowing which would remove pressure from the Fed to be hawkish.
At some point, the combination of a hawkish Fed and a slowing economy will succeed in driving inflation lower. However, the only uncertainty is how much damage will be inflicted on the economy.
Regardless of gold, this sequence will be bearish as it will result in higher real rates. Ultimately, this is the fundamental driver of gold prices as it benefits when real rates are low or negative and sees outflows when investors can earn positive returns on no risk which is what happens with rising short-term rates and falling inflation.
Already, gold prices are down 8% YTD and silver prices are down 21%. Both are hovering near 2-year lows and could break down with further data showing strength in the labor market and the Fed continuing to hike aggressively.
