As the Dollar Falls, Metals Will Rise

Precious metals did well compared to other assets in 2023, but not as well as many goldbugs expected given the highest price inflation in decades. The anemic price action was another indication of artificial forces in the markets and broken price discovery.

Trading algorithms were not programmed to buy metal when prices rise for real world goods and services. They responded instead to the dollar’s strength or weakness in the foreign exchange markets.

Purchasing power of the Federal Reserve note “dollar” collapsed here at home, but that dismal performance was still outstanding when compared to major world currencies.

The dollar peaked at over 114 on the DXY index at the end of September. Gold put in its low for the year ($1,622/oz) at the same time.

The greenback has since dwindled to 103.91 while gold is ripping higher. While metal prices remain locked in an inverse correlation with the DXY, investors want to know where that index is headed.

Fed policy in the months ahead will be a major factor. The dollar’s peak late in the third quarter was the product of an unprecedented series of interest rate hikes by the FOMC.

Central bankers in the U.S. aggressively tightened while their counterparts around the world kept their feet off the brakes.

Currency traders now anticipate the Fed will soon make the long-awaited “pivot.”

Price inflation, as measured by the CPI, has slowed a bit. More importantly, the pain associated with dramatically higher interest rates is ratcheting higher:

• Home sales have fallen sharply, and the worst may be yet to come.
• The NASDAQ is down roughly 30%, and the tech sector is laying off people.
• Retailers saw consumers tightening their belts around Christmas.

Two of the most reliable indicators are signaling a recession is on the way. The Leading Economic Indicators have turned negative, and the yield curve for interest rates has been inverted for months.

The world will soon find out just how much tolerance for pain Jerome Powell and the rest of the FOMC has. He talks a good game when it comes to the Fed’s resolve to crush price inflation. Talk from central bankers is about as cheap as it gets.

The other consideration in determining where the DXY is headed is how central bankers and traders will treat other major currencies.

The British pound lost nearly 12% relative to the dollar last year. The euro lost almost 9% and the yen dropped more than 22%. While price inflation was a major story here in the US, it is becoming a bona fide crisis elsewhere in the world.

Central bankers in those countries are playing catch up with the Fed. The Bank of England has been hiking rates. The same is true for the European Central bank. The Bank of Japan surprised markets by finally beginning to tighten policy last month.

Officials there do not want a repeat of what happened in 2022. Another double-digit decline against the U.S. dollar and the domestic price inflation that comes with it present serious challenges. Inflation that hot can easily spiral out of control.

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