FISCAL/MONETARY UPDATE – THE CAPITAL MARKETS EVALUATE THE POSSIBILITY OF SOFT LANDING AND LOWER INFLATION – DON’T COUNT ON IT!

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The stock market was firm in July as equity investors continued to hope for a “soft landing” in the economy. The bond market however provided higher rates, close to the recent highs, with short term US treasury bill rates back over 5%, as the Federal Reserve indicated one or two more 25 basis point increases are likely. Gold bullion was generally firm, up about 2% for the month and gold mining stocks were up about double that, bringing both bullion and miners to a similar gain of about 7% for the year. The gold mining stocks, which our investment partnership has favored for the last decade generally move at a multiple (2-4x as much) as bullion, due to the operating leverage, but the investment community has yet to believe that inflation, and higher gold prices, are here to stay.  More on this below.

Fed Chairman Jerome Powell, while not specifically abandoning the objective of only 2% annual inflation, just last week indicated that the first rate cut will be in ’24, though inflation will not reach 2% until ’25. Forget about the fact that inflation is never “transitory” as he believed a couple of years ago. Prices are higher by an understated 20% over the last two years, will move higher from here and never going down. Actually, about two points of the recent decline from inflation of 6% to 4% was from the decline in the price of oil and about half of that has already been retraced just in July.

The Fed seems to look primarily at lagging indicators but a number of leading indicators show that higher inflation and higher interest rates are likely soon, choking off the “soft landing” and requiring a new easing cycle by the Fed before inflation goes lower from here. Oil, now at $81.60 per barrel is up 22% over the past five weeks and food costs are on the rise again. Teamsters have just reached agreement for higher wages, almost 10%/year over five years, so, along with rising energy prices, distribution of all kinds of goods will be that much more expensive. The US Dollar index, versus other currencies is weakening, and the trade deficit was almost $100B last month, both feeding US inflation.

Since the US debt ceiling was lifted in June, the National Debt has exploded upward by $1.3 trillion to $32.7 trillion, with the annual deficit approaching $2 trillion. Interest expense on the debt, $852 billion for the last 12 months is 75% higher than 2 years ago. Since the average interest rate is still only 2.76%, with half the public debt maturing within 3 years, the 5% current short term rate will take the annual interest expense well over one trillion dollars within two years. As far as funding the deficit and the debt, foreign buyers, the Chinese, Japanese and others, are backing away so it can be said that our Federal Reserve, the traditional buyer of last resort, has become “the only resort”. The money printing that will be necessary to support our economy, indeed the worldwide economy, will be inflationary, far from transitory, and will finally convince investors that much higher gold prices are in the cards and here to stay.

Lastly, it is worth nothing that there will be a “BRIC” (Brazil, Russia, India & China) led conference in South Africa (August 22-24) that could be a catalyst for gold. There are reportedly more than 40 countries wanting to join the group, many of them looking to reduce their dollar based holdings and add gold. It would not be surprising that there will be a great deal of anti-dollar & pro- gold chatter as a result of this gathering.

Roger Lipton