A golden opportunity

Mikael Syding
18 Apr 2023 | 4 min read

JP Morgan presented a strong report at the same time as the retail trade in the US surprised negatively. This is exactly what you would expect when higher interest rates make the banks charge more from their customers without paying extra for the deposits (the interest on regular bank accounts)

Customers get less money to shop for. The positive profit effect applies in particular to the largest banks, where the deposit money goes when you become worried about the stability of the small banks.

But in the next phase, especially if the central bank guarantees all depositors' funds, while money funds increase their market share, the competition for the cheap financing increases. Increased deposit rates and increased competition may mean even less lending. The result is less consumption, less investment, fewer employees and thus ultimately the labor market tipping over into recession. It quickly turns into a spiral where more unemployed people lead to increased credit losses and lower consumption, which leads to even more redundancies.

Business tends to retain its employees until the end, which is why job data is the most lagging of all economic indicators. At the same time, it is precisely the jobs data that the central banks, not least the Fed, are looking at when they raise interest rates to fight inflation, even though the economy is on the brink of a lending-led recession.

As I said, the reporting season has just begun. As usual, it will be stronger than expected. This probably applies to both banks and consumer companies. The layoffs haven't started yet. Still, 7% lower profits than Q1 2022 are expected, so de facto we are in a weak period in absolute terms. However, what the market is debating is whether we are close to the bottom of the slump, and whether a pivot to lower interest rates can support share prices regardless of how weak earnings are. Seven percent lower profits are most likely a rounding error if the profit multiples simultaneously rise by 15% from 16 to 18.5 when the discount rate falls by 15% from 8% to 7%.

I am quite convinced that the new higher interest rates will lead to a weaker economy and even faster falling corporate profits. That is actually the point of interest rate increases. They want to cool down the economy to avoid that high inflation expectations are established and bite into the economy in the longer term.

There are several important factors that are putting pressure on consumers: lower house prices, higher interest costs, banks that are less willing to lend (they get, among other things, higher risk weights and higher credit losses due to the weakening of the economy), and higher energy prices. The problem is that the Fed and several central banks do not realize this as they stare blindly at the lagging job statistics. They are still raising the interest rate this spring, despite the fact that the effects of this will not be properly seen until a full year from now. It exacerbates the spiral of reduced lending, reduced consumption, reduced profits, increased unemployment, even weaker consumption, profits and the labor market. That makes me think this cycle will be reminiscent of 2001 and 2008, when the S&P 500 fell by over 50 percent after the Fed began its interest rate cuts due to the threat of recession.

Despite massive monetary stimulus, and in theory reduced required returns, the decline in profits was so severe (profit margins are higher now) and the initial valuation so high (it's even higher now) that the stock market was still halved. A replay is certainly perfectly reasonable.

The question is what one should own instead of expensive stocks. Firstly, there are always cheap shares, e.g. Swedish banks and large oil companies, but I think it is even better to look for other assets, e.g. monetary commodities such as Bitcoin, Ether, gold and silver. The reason is that the weak economy will force the Fed to change its footing. Really! Just as with previous policy mistakes such as 2001 and 2008 when they turned around too late, cheated by a strong labor market.

The cryptocurrencies have trended strongly this year and it is often wise to catch the crypto trend when it gathers momentum. However, it is still my main track that Bitcoin and Ether will fall along with other risk assets in the next 12 months. But at the same time, I think that today's $31,000 and $2,100 for BTC and ETH respectively are only about a fifth of what they could be in a few years. So you should really avoid selling yourself unnecessarily in the hope of buying even cheaper, at least as long as the trend is positive.

In practice, this means that I think you can buy more of the cryptocurrencies here, but dance close to the exit and thus be prepared to sell the overallocation if it turns down. It's a difficult strategy, of course, because it's easy to get shaken up in the swings. Above all, I mean that you should maintain the basic position you already have.

Gold and silver are also interesting. When gold has gathered enough momentum, the gold companies and the metal silver usually follow suit. If gold is going up e.g. 50% from 2000 USD to 3000 USD/ounce, silver will probably go up around 150% from today's 25 USD/ounce. Technically, one can ask whether the price rise above USD 2000 this week was a so-called false breakout upwards and that the rate now falls back towards e.g. 1800 before it gains new momentum towards the all time high. Alternatively, today's drop from around $2050 to just below $2000 is the false signal.

I believe in the latter. I think gold has now finally broken above 2000 and is going well above old highs. In fact, I think $3000 could be within reach as early as this year, driven by a weaker stock market and a Fed pivot to lower interest rates. There is still money that has to be somewhere and when the stock market is not doing well, there are always some who look for gold. The ETF sector's exposure to gold is near record lows so there are many who could potentially switch to increased gold exposure and drive the price higher. Although it is clear, if gold is really going to 3000, then it is gold companies or silver that will do the strongest. Maybe you should even strike silver mines if you buy the scenario. Hecla Mining could possibly become a real rocket if the scenario is fulfilled, but the smartest thing to do is to take a slightly more sustainable position with most of the capital and then gold is the safest. This is especially true now that you got one last chance to buy below $2000/ounce.


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