Stumbling Manufacturing and Rising Gold - Now or Later? / Commodities / Gold & Silver 2019

American manufacturersare scoring ever deeper recessionaryreadings. We haven’t seen this bad an ISM Manufacturing reading in quitea while. Can it take the broader economy with it? And what about gold – whenexactly will it get its shine?

ISMManufacturing Index Drops To Disturbingly Low Level

The September ISM Manufacturing Index registered 47.8percent, a decrease of 1.3 percentage points from the August reading of 49.1percent. It’s not only below 50 percent, which indicates a contraction, but it’s actually the lowest level since June2009, when the GreatRecession formally ended, as the chart belowshows.

Chart 1: The US ISM Manufacturing PMI from 2009 to2019

The sharp decline in the index rattled the WallStreet, sending the stock market sharplylower.  President Trump also got upset.He tweeted:

As Ipredicted, Jay Powell and the Federal Reserve have allowed the Dollar to get sostrong, especially relative to ALL other currencies, that our manufacturers arebeing negatively affected. Fed Rate too high. They are their own worst enemies,they don’t have a clue. Pathetic!

It’s always great idea to make fun of the centralbankers who think they can set the adequate interestrates and run complex economy. And, yes,Trump is right that the strong US dollar is nothelping the American manufacturers. But the non-manufacturing part of theeconomy continues its expansion, while the unemploymentrate remains very low. In such anenvironment, to further lower the interest rates would only add fuel to excessiverisk-taking, indebtedness and irrational exuberance in the asset markets. Theunpleasant truth is that the current level of interest rates is unprecedentedand it should be normalized. Yes, this is a painful process – and this is why the Fed is in a trap without any goodsolutions – it either normalizes the monetarypolicy risking a slowdown or financialcrisis, or it eases further, creatinglarger macroeconomic imbalances that risk an even greater economiccrisis later on.

What is missing in Trump’s tweet is, of course, anyreference to the US-China trade war, although global trade remains the most significantissue for manufacturers. As one executive said “Chinese tariffs going upare hurting our business. Most of the materials are not made in the U.S. andmade only in China.” So, it’s really ironic that Trump blasts the Fed thatalready cut the federalfunds rate by 50 basis points to save theeconomy from Trump’s trade war.

Implicationsfor Gold

What does the manufacturing recession imply for thegold market? Well, in theory, it shouldbe positive for the yellow metal, which shines the brightest during recessions.However, we have so far just a manufacturing recession, not the broad slump ofthe whole economy. Although the significance of manufacturing in the economy isoften underestimated (many services depend on manufacturing for their ownexpansion), the U.S. economy foremost relies on services. 

Let’s look at the chart below, which shows the earlierepisode of industrial downturn. As one can see, 2015 was a terrible year forthe U.S. industrial production. But golddid not shine then. Actually, it has been declining and it rebounded onlywhen industrial production bottomed out.

Chart 2: Industrial production (green line, left axis,annual % change) and gold prices (yellow line, right axis, London P.M. fix, in$) from 2014 to 2019

So, a mere manufacturing recession does not have toboost gold prices. Of course, today’s situation is different from that in 2015.First of all, the 2015 slump was mainly caused by plunge in oil prices andlower energy-related investment, while today we experience global slowdownmagnified by trade wars that nobody wins). Second, the macroeconomic context isdifferent. Bond yields are lower,the Fed is more dovish. And the yield curve hasinverted, which suggests that recession in manufacturing could spill over tothe broad economy. And this is somethingthat the gold bulls are waiting for.

Thank you.

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Arkadiusz Sieron

Sunshine Profits‘ MarketOverview Editor

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