Commodity Insight: Canary in the coal mine for stocks and commodities

Fears are growing that the Federal Reserve is pushing interest rates too high too fast and the results will lead to a recession — a Fed-induced recession that could be far more severe than many expect.

And history shows that as U.S. interest rates rise, the dollar tends to rise, as well. This week, the dollar hit a new 20-year high.

The combination of rising rates and an unusually strong dollar is causing angst for stocks and commodities.

The Fed kept interest rates at zero for a decade while embarking on a policy of quantitative easing and created an asset bubble with stocks. Now, the Fed is not only ending that policy, but reversing it, as well.

As a result, stocks, bonds and most commodity markets have been heading south, making the year 2022 historically bearish.

Stanley Druckenmiller, legendary billionaire investor, weighed in and said, “We are in deep trouble.”

From CNBC while interviewing Druckenmiller: “The Fed is now in the middle of its most aggressive pace of tightening since the 1980s. The central bank last week raised rates by three-quarters of a percentage point for a third straight time and pledged more hikes to beat inflation, triggering a big sell-off in risk assets.”

One of the oldest sayings in finance is “Don’t fight the Fed.” The reason is simple — the Fed always gets what it wants.

What the Fed wants now is to slay inflation. That means prices, valuations and bull markets are more likely headed lower than higher.

The big question, which cannot be answered except with the benefit of hindsight, is this: Does the Fed policy of hiking rates the most aggressively in 40 years lead to a soft or hard economic landing?

More and more widely respected analysts and brokerage firms fear a hard landing with the economy as they believe the Fed is too aggressive in trying to slay inflation. A hard landing is the big threat in today’s marketplace.

Understand the stock market has been moving higher since August 1982. In fact, between 1966 and 1982 the Dow Jones Industrial Average was stuck in a trading range of 600 to 1,000.

Finally, after 17 years the Dow broke out to the upside and headed higher in August 1982. Never again did the Dow drop below 1,000.

From 1982 until this year investing in the stock market was quite profitable for those that only went long and never got out.

During that period the best friend investors had was the Fed. The Fed would continue to support equities with lower interest rates whenever stocks showed serious signs of heading south.

Today, on the other hand, the Fed is not the best friend of investors — not as long as interest rates are being lifted at the fastest pace in 40 years.

In the past few days, Goldman Sachs and Black Rock, two of the world’s leading financial institutions that are widely followed with solid track records, turned sour on the stock market.

Black Rock stated, “We shun most stocks” as recession is not priced yet. And according to a headline this week from MarketWatch, “Goldman Sachs turns bearish on stocks.”

The fact some major brokerage houses are being spooked by a hawkish Fed is not something to ignore.

Imagine walking into a new car showroom and the floor manager greets you with a frown and says, “I am glad you are here, but don’t buy a car from us. Don’t do it. Come back another time and I will gladly sell you a car. But don’t buy a car from us now.” Can you imagine such a scene?

Unfortunately, the world of commodities is encountering the same bearish fundamentals that are impacting the stock market. The aggressive nature of the Fed pushing rates higher and higher is bullish for the dollar.

And history shows clearly that a strong dollar keeps a lid on most commodity markets. The dollar today is hugging a 20-year high.

The gold market has long been viewed as a hedge against inflation. As inflation rises, so do gold prices.

The last read on U.S. inflation was a gain of 8.2% over a year ago. But last week gold prices fell to a two and a half year low.

The reason gold stumbled is for two reasons — the Fed hiking rates and the dollar being king.

At times, coal miners used to take canaries into coal mines with them. Canaries are more sensitive to dangerous gasses than humans are.

If the canary died, the miners knew there were dangerous gasses present and would leave the mine.

Today, the Fed hiking rates aggressively and the dollar being king are the canaries in the coal mine for stocks and commodities. Don’t fight the Fed.