Is a Major Dollar Sell-Off Around the Corner?

In my last write-up, I shared some of my longer-term views on a few different markets.  In discussing one of my favorite ideas, the ongoing bull markets in gold and silver, I noted that the corrective price action that I warned my readers about on April 14, 2024, may have been complete.  I felt that if that were the case, then the overbought conditions from the fierce rally from $21.94 to $29.79 should have been balanced out by then, and accordingly, we should be getting ready for a move to new highs. 

In fact, silver has staged a powerful rally since putting in its very recent low of $26, climbing nearly 6% in about ten days. If you look closely at the chart of silver below, you will notice that the entire rally of roughly seven dollars and eighty cents started in the middle of February and lasted about two months. 

I have always followed the basic principle that when markets get way overextended, they can correct this imbalance through price, through time, or through some combination of the two.  In this instance, silver offered us a wonderful scenario in which it corrected about 49% of the entire rally from the middle of February to the middle of April. 

That is nearly perfect, as I like corrections that approximate Fibonacci retracement ratios. Silver also gave us the additional gift of correcting its two-month rally with a sharp correction that lasted almost 38% of the time the rally took.  It is rare for a market to behave in such a strangely symmetrical way, with clean Fibonacci relationships for the corrections in terms of price and time.   I thought the “coincidence” was just too convenient to ignore, so I told my readers it was quite possibly the end of the correction and time to look for a move to new, multi-year highs.

Gold has followed a similar path.  Although the magnitude of silver’s rally from mid-February was more explosive, having rallied about 36%, gold still had a fabulous move higher of nearly 22%.   Gold’s correction, price-wise, proved to be a little less than 38%, another Fibonacci retracement level.  The duration of this correction almost matched exactly the percentage of the price correction, with the sell-off lasting about 38% of the time of the rally.  Gold corrected enough both price-wise and time-wise, so there is a very good chance that its major bull run is already commencing.  The rally since the recent lows has gone about 3.5%.  Silver typically trades at a much higher volatility than gold, so it makes perfect sense that the relative magnitude of its moves reflects its more volatile nature.

Overall, I persist with my long-term bullish views on these precious metals.  The United States is almost certainly going to try to inflate its way out of its fiscal timebomb.  As the dollar’s buying power continues to be eroded by the Fed’s inflationary policies, the relative magnitude of the total indebtedness will be smaller, as the true dollar value of the debt has depreciated.  In fact, the Treasury Department has been borrowing and spending like we are in a crushing depression.  Our federal deficit now grows by $1 trillion every 100 days,  and the authorities are intent on doing everything they can to at least give the appearance of sufficient growth in our economy to justify the ever-growing debt levels.  With the dollar’s real value weakening, real assets, like precious metals, will benefit in this sort of economic scenario.

This is one of the obvious by-products of self-interested Congressional leaders who implement short-sighted policies that are designed to keep them in power, rather than implement policies that will leave a healthier financial legacy for our children and grandchildren to inherit.  It doesn’t take a macroeconomic genius to see that the explosion in Federal debt since 2010 is dangerous and unsustainable on its current path.  It was irresponsible policies that led to the Great Financial Crisis, and our way out of the crisis has been a perfect example of kicking a massive problem down the road in the hopes that the next bunch of bureaucrats will figure out how to handle the ever-growing mess.  In the worst case, the bureaucrats who are kicking the problem down the road are at least hoping that the future bureaucrats will get blamed if and when things finally blow up.

Of course, it is not just Congress that is the problem here.  Consider the following chart, which should be quite familiar to many of you by now.

The Fed’s own Financial Conditions Index shows us clearly that we have financial conditions today that are essentially equivalent to the extremely easy financial conditions that we had in the first quarter of 2010, when the Fed had pumped vast amounts of liquidity into the system and driven interest rates down from 5.5% to .15%.  Even if interest rates today are 5.5%, our financial conditions are easy.  Put differently, it is a bald-faced lie to suggest that we have even moderately restrictive policies in force today.  It is no wonder that inflation has been ticking up since the start of 2024!  Today’s PPI numbers came in much worse than expected, but Powell still insisted when he spoke after the numbers that inflation is heading lower, and accordingly, the next move in interest rates will be lower.  

There are a couple of anomalies that help explain why conditions are so loose despite the higher interest rates.  One of these anomalies is that roughly 40% of all homeowners have no mortgage.  Therefore, for them, the high mortgage rates in today’s market don’t create a crushing problem.  It is only a problem if they want to sell their homes, as taking out a new mortgage could prove to be very expensive. Another anomaly is that the majority of homeowners with mortgages refinanced soon after Covid, when interest rates were much lower.  

Whether we look at the Fed’s balance sheet, which is more than $5 trillion bigger than it was in 2010, or the Federal Government’s cumulative debt, which is nearly $22 trillion bigger than it was in 2010, it is clear that the authorities have been trying to mask a huge problem.  There is no other way to explain why these numbers keep growing at a terrifying pace.

Why is the Fed dramatically reducing the roll-off of its balance sheet when inflation is still running so hot, unless there is an even scarier problem hiding in the shadows?  Likewise, why is Treasury borrowing and spending at its totally irresponsible pace unless it is absolutely terrified that things will crash if they stop artificially propping things up with their spending?  Sure, there are some political motivations driving this dangerous behavior as well, but there is more going on than just a bunch of power-seeking people in D.C. struggling to stay in power.  The people in Congress and the Fed can all get cushy jobs when they go to the private sector, so the thirst for power can’t possibly explain it all.  The system is out of balance, so it is no wonder that I am long-term so constructive on real assets such as gold and silver.

I am likewise a big fan of large allocations to other types of real assets such as timber and agricultural lands.  They provide excellent annual returns, provide wonderful environmental benefits, and provide great hedges against inflation. Remember, the so-called price stability of our central bank, with its 2% annual inflation rate, is designed for the dollar to lose half of its value every thirty-five years.  Yes, it is a perfect example of the boiled frog syndrome, except it is our buying power that is slowly being boiled and murdered over time.  It is only over time that people start howling from the cumulative pain of the price increases.  It is not unlike the poor frog that will jump out of a pot of boiling water quickly if the water is very hot.  It is only when the temperature of the water is slowly increased that the frog will just sadly stay in the water and boil to death. Slow and steady inflation is annoying, but it is usually endured silently, while sharply higher inflation will quickly lead to more aggressive reactions from consumers.

I fully expect the Fed and the Treasury to start parading a bunch of famous economists around to the various news outlets to explain why 3% inflation is not a long-term problem.  That will give the Fed the political cover to allow inflation to hover at 3%, or higher, while Powell prays that inflation drops further without any further rate hikes.  I have seen a few of these economists so far, trying to justify an annual inflation rate of 3% or higher.  There will be more of these sales pitches over the coming weeks and months, as the Fed seems absolutely determined not to raise rates, no matter what, even if means our dollar’s buying power halves in 23 years (due to 3% annual inflation), or perhaps even faster.  The sad truth is that inflation primarily acts as a tax on the poor and middle class.  The wealthy people benefit from some inflation because the value of their assets is growing at the rate of inflation.  Runaway inflation is another matter altogether, and many a great empire has been crushed under its weight.

The hegemonic power of the US helps ensure a steady stream of global investors who support the value of the dollar.  The US is still able to dictate that most commodity transactions are priced in dollars, so for the time being, the dollar is the only true global currency.  This means that most global trade is conducted in dollars, and there is a constant demand for dollars.  If we shift to a panic phase, however, when investors want to bail out of dollars, then we will face a truly scary, existential threat.  We are not yet at the panic phase when global investors flee from the dollar en masse, but I feel strongly that we should all layer in some protection in the form of real assets in our portfolios in order to protect ourselves from a possible doomsday economic situation in the next ten years of so.  

In the meanwhile, I do expect some significant dollar selling pressure to emerge over the coming months.  If inflation does start to drop towards the Fed’s 2% target, the Fed will almost certainly start cutting interest rates aggressively. This will lead to a somewhat controlled, steady dollar sell-off as interest rate differentials narrow Alternatively, if inflation remains elevated, then we could face more of a panic sell-off in the dollar.  Persistently high inflation will ultimately lead to the emergence of severe economic problems, which in turn would raise the specter of an economic scenario which looks and feels very much like stagflation.  It is in that scenario that the stock market could turn very, very bearish.

The combination of massive unrealized losses on the books of the banks from their securities holdings, coupled with the huge commercial real estate headwinds I have written about previously, and the need for Treasury to keep raising funds placed the Fed between the proverbial rock and hard place.  The Fed is desperate to lower rates to ease some of these very real and very large problems, but the inflationary price pressures seem quite ingrained for the time being.  

There are other existential threats sitting in the background.  Hopefully, they never manifest, but the risk of fat-tailed market meltdowns are higher than they have been for many, many years, maybe higher than they have been for many decades.  The political turmoil of a brutally contested presidential race could wreak havoc in our system.  Right now, things are priced to perfection in the equity markets.  Imagine, however, how the markets would behave if our hotly contested presidential election turns chaotic with the unlikely, but not impossible scenario of the winning candidate sitting in jail.  It would have been unimaginable for our country’s first 248 years of existence, but it is not unimaginable now.  

Another factor that we need to consider is the current level of unrest on the college campuses.  We can label it as performative art, and dismiss it as noise that will go away, but these protests are well-funded, and they fit perfectly into the designs of enemies of America. 

Frankly, I have recently witnessed college protests first-hand at my daughter’s graduation, and the protestors were hardly innocent.  They were scary and they said hideous things.  I experienced screaming  protesters, shouting out messages of hate and death to a nation, blocking traffic, and even temporarily blocking our entry to the commencement ceremonies until our sheer numbers allowed us to push through their chain of resistance while the police stood by watching and doing absolutely nothing.  These people were  trying to incite others to join their angry mob, and most of us were at least a little frightened. This was something I never expected to experience.  Not more than thirty yards from where I had just walked, an elderly Jewish grandmother, attending her granddaughter’s graduation, got punched in the face and knocked to the ground simply because she said to one of the protesters that her family had died in the holocaust and that the situation is far more complex than it might seem to protesters thousands of miles from Israel.  The fact that many of these protesters at the colleges aren’t even students just adds to the overall risk, as their incentive is clearly to create unrest and destabilize.

Is this really what our country has become?  Is this truly how we are supposed to exercise our right to self-expression?  We know from history that protests have a way of spinning out of control due to the behavior of people in crowds and mobs.  Crowd behavior can create conditions of temporary insanity when people lose their minds and their self-control, and this sort of civil unrest can lead to widespread social instability that can go in many directions.  I am not saying that these college protests against Israel will lead to a general breakdown in our society, but I am saying that we can’t rule out a further escalation in these protests  and further societal  unrest. In any event, I don’t believe we currently have an encouraging, long-term scenario for stocks, which are pricing in a Goldilocks, soft-landing scenario in the economy.  Sure, they can have another run to all-time highs, but the downside risks are increasing.  

Wishing you all the best of luck with your trading in the markets.

Sincerely, 

Andy Krieger