There are a handful of leading economic indicators that when taken together have provided timely warnings of every US recession and recovery for at least the past sixty years. A monthly feature at TSI is a discussion, primarily based on these indicators but also taking into account expected monetary and fiscal policies, of the prospects for the US economy over the ensuing 6-12 months.

At the end of 2019, before anyone outside Wuhan had heard of the new coronavirus, the leading indicators we track pointed to a 60% probability of the US economy entering recession during the first half of 2020 and an 80% probability of the US economy entering recession before the end of 2020. The only reason the probabilities weren’t even higher was the possibility that the Fed’s money pumping following its 2019 “pivot” would push the recession start into 2021. The lockdowns of March-2020 eliminated any possibility that the inevitable recession would be postponed.

By early-July of 2020 it became clear, based on the same leading indicators, that the recession catalysed by the H1-2020 lockdowns was over. This informed our decision to begin favouring industrial commodities over gold.

It’s important to continue weighing new data and making adjustments in real time as required, but based on what is currently known the probability of the US economy slipping back into recession during the first half of 2021 is extremely low. There is, however, an uncomfortably high probability of the US economy re-entering recession territory during 2022.

Here’s what we wrote in our latest monthly US Recession/Recovery Watch, which was part of a commentary published at TSI last week:

We called an end to the 2020 US recession in early-July of last year, mainly due to the spectacular rise in the ISM New Orders Index (NOI) that had just occurred. This call has been supported by subsequent data and eventually should be confirmed by the National Bureau of Economic Research (NBER)*, making last year’s recession the shortest in US history. The latest ISM data, which were published earlier this week, indicate that the recovery is intact.

The following monthly chart shows that the NOI remains near the top of its 20-year range, meaning that the US economy continues to recover from the devastation caused by the lockdowns directed by the government during the first half of last year.

Based on the economic and monetary data published over the past couple of months it’s possible that later this month the US government’s statisticians will report annualised nominal GDP growth of at least 10% for Q4-2020 and likely that the US economy will achieve annualised nominal GDP growth of at least 5% during the first half of 2021. Are you long industrial commodity stocks?

The strength is largely artificial and will evaporate soon after the Fed is forced by blatant evidence of an inflation problem to end the monetary stimulus, but that is probably a story for the second half of this year and beyond. Over the next 1-2 quarters it’s a good bet that the monetary tsunami will continue, courtesy of both the Fed and the government. For example, the US federal government has just sent $600 “stimulus” checks to most Americans, but that won’t be the end of it. President-elect Biden wants to send another $2000 to every American and a massive infrastructure spending program is ‘on the cards’.

It’s amazing what the government can do when it stops pretending to care about its own indebtedness and embraces the spirt of Modern Monetary Theory (MMT).

*It can take the NBER, the official arbiter of US recession dates, a year or more to confirm a recession start/end date.

[This post is an excerpt from a commentary posted at TSI last month]

Gold mining is — to use technical jargon — a crappy business. It doesn’t have to be, it just works out that way due to irresistible incentives associated with the post-1970 monetary system. We explained why in TSI commentaries and some articles at the TSI Blog (for example, HERE) during 2014-2015.

The explanation revolves around the boom-bust cycle caused by the monetary machinations of the banking establishment (the central bank and the commercial banks). For the economy as a whole, malinvestment occurs during the boom phase of the cycle and the bust phase is when the proverbial chickens come home to roost (the investing mistakes are recognised and a general liquidation occurs). For the gold mining industry, however, the malinvestment occurs during the economy’s bust phase, because the boom for gold mining coincides with the bust for the broad economy.

To further explain, rapid monetary inflation distorts relative price signals and in doing so incentivises investments that for a while (usually at least a few years) create the impression that the economy is powering ahead. Eventually, however, many of these investments are revealed for what they are (ill-conceived), with the revelation stemming from rising costs, declining profits or the absence of profit, resource shortages within the economic sectors that ‘boomed’ the most, and rising short-term interest rates due to a scramble for financing to complete projects and/or deal with cash flow problems.

After it starts to become clear that many of the boom-time investments were based on unrealistic expectations, a general drive to become more liquid gets underway. Many people sell whatever they can in an effort to pay expenses and service debts, thus kicking off an economic bust (recession or depression).

For the average person, becoming more ‘liquid’ usually involves obtaining more cash. However, corporations and high-net-worth individuals often prefer other forms of ‘liquidity’, including Treasury Bills and gold. That, in essence, is why the demand for gold tends to rise during the bust phase of the economy-wide boom-bust cycle.

The rising demand for gold pushes up gold’s price relative to the prices of most other assets and commodities, which elevates the general interest in gold mining. Eventually there will be a flood of money towards the gold mining industry that boosts valuations and that the managers of gold mining companies will use for something. That something will be project developments or acquisitions.

Regardless of how high market valuations move or how costly new mine developments become, gold-mining company managers will never say: “We don’t want your money because there currently are no acquisitions or new projects that make economic sense.” Instead, they will take the money and put it to work, based on the assumption that current price trends can be extrapolated into the distant future. The result invariably will be an artificial boom in the gold mining industry characterised by a cluster of high-cost investments that eventually get revealed as ill-conceived. Massive write-offs and an industry-wide retrenchment will ensue as surely as night follows day, thus obliterating the wealth created by the industry during the boom.

Gold itself is not made less valuable by the monetary-inflation-caused inefficiencies and widespread wastage that periodically beset the gold-mining industry. That’s why the gold mining sector, as represented on the following weekly chart by the Barrons Gold Mining Index prior to 1995 and the HUI thereafter, has been in a downward trend relative to gold bullion since 1968. That’s right — gold mining stocks, as a group, have been trending downwards relative to gold for more than 50 years!

The trend illustrated by the above chart is a function of the current monetary system and won’t end before the current system is replaced. The trend could end within the next ten years, but it didn’t end in 2020 and almost certainly won’t end in 2021 or 2022. An implication is that if you want to make a long-term investment in gold, then buy gold. Gold mining stocks are for trading.

1. There is no longer any correlation between bank reserves and the economy-wide money supply, meaning that the “money multiplier” taught in economics classes no longer applies.

2. In the US the government-Fed combination can increase the money supply to almost any extent independently of the private banks. That is, monetary inflation does not rely on the expansion of credit via the private banking industry.

3. The Fed is not constrained in any way by the need/desire to maintain a strong balance sheet.

4. The bulk of the central bank’s money creation involves the monetising of EXISTING assets, meaning that the central bank can increase the money supply without increasing the economy-wide quantity of debt. Furthermore, the central bank is capable of monetising almost anything.

5. A motivated central bank will always be able to increase the money supply, and growth in the money supply always leads to higher prices SOMEWHERE in the economy. For speculators and investors, the challenge is to figure out where.

6. The bond and currency markets eventually could impose practical limits on government borrowing and monetary inflation, but the government will be free to borrow and the Fed will be free to inflate as long as the bond and currency markets remain cooperative.

7. A corollary of points 5 and 6 is that the probability of the US experiencing deflation will remain low until after the T-Bond and/or the US$ tank. Putting it another way, the probability of the US experiencing deflation will remain low until after inflation is widely perceived to be a major problem.

8. There are long and variable time delays between changes in the money supply and the appearance of the price-related effects of these changes. This leads to an inverse relationship between the rate of monetary inflation and the fear of inflation, because the average person’s fears/expectations are based on the effects of previous money-supply changes as opposed to what’s currently happening on the monetary front.

9. An increase in the general price level is not the most important effect of monetary inflation. Of far greater importance: monetary inflation changes the STRUCTURE of the economy in an adverse way, by a) distorting relative prices, leading to malinvestment on a broad scale, and b) transferring undeserved benefits to the first receivers of the new money at the expense of everyone else.

10. Because monetary stimulus changes the structure of the economy, its bad effects cannot be cancelled-out by the subsequent withdrawal of the stimulus. Instead, the distortions/wastage caused by monetary stimulus will be revealed after the flow of new money is restricted. An attempt to sustain the stimulus indefinitely, and thus avoid the collapse that inevitably follows a period of inflation-fueled ‘growth’, will end in hyperinflation.

11. “Money velocity” is a redundant concept at best and a misleading one at worst. The same can be said about the famous Equation of Exchange (MV = PT), which is where money velocity (V) comes from. In the real world there is money supply and there is money demand; there is no such thing as money velocity.

12. Falling prices are never a problem — they are either the natural consequence of increasing productivity (real economic growth) or part of the solution to a problem (in the case of a bursting credit bubble).

13. A corollary of point 12 is that the central bank’s attempts to force prices to rise either counteract the benefits of increasing productivity or prevent the correction of the problems stemming from a credit bubble.

14. Credit expansion can foster sustainable economic growth only when it involves the lending of real savings by private individuals or corporations.

15. Economic growth is driven by savings and production, not consumer spending.

16. The government and the central bank have no real capital or wealth that can be used to help the economy in times of trouble. Therefore, monetary and fiscal “stimulus” programs involve stealing from one set of people and giving to another set of people. Obviously, the economy cannot be strengthened by large-scale theft.

A lot of widely held beliefs associated with the financial markets and the economy are in conflict with the historical record and/or logic. One that I have addressed many times in the past (most recently HERE) is the belief that gold tends to be relatively strong when inflation expectations are rising.

Rising inflation expectations eventually could transform into a collapse in monetary/economic confidence, at which point gold would exhibit extreme relative strength. However, the run-of-the-mill increases in inflation expectations that occurred over the past few decades generally led to weakness in gold relative to the basket of commodities represented by the S&P Spot Commodity Index (GNX).

Here’s an update of the chart I have presented in previous blog posts that illustrates the relationship mentioned above. The chart shows a strong positive correlation over the past four years between the GNX/gold ratio and RINF, an ETF designed to move in the same direction as the expected CPI. That is, the chart shows that a broad basket of commodities tended to outperform gold during periods when inflation expectations were rising and underperform gold during periods when inflation expectations were falling.

As an aside, related to the above chart is the following chart comparing the commodity/gold (GNX/gold) ratio with the yield on the 10-year Treasury Note (TNX). Given the positive correlation between the commodity/gold ratio and inflation expectations, it isn’t surprising that there is a positive correlation between the commodity/gold ratio and the 10-year interest rate.

This year, inflation expectations bottomed in March and then trended higher. That’s the main reason why, in TSI commentaries over the past seven months and especially over the past two months, I have written that it was appropriate to favour industrial commodities over gold.

I currently expect the rising inflation expectations trend to continue for another 2-3 quarters. This means that I expect continued outperformance by industrial commodities for another 2-3 quarters, of course with corrections along the way. A correction (a period of relative strength in the gold price) actually could begin soon, partly because the gold price is now stretched to the downside while the prices of commodities such as copper, zinc, oil and iron-ore are stretched to the upside.