Saturday, September 29, 2018

Gold and inflation... Waiting for the reaction or is there something missing in the inflation story

Is there market complacency concerning inflation? One place to look for complacency is in the gold market. Using the CPI as our benchmark, annual percentage inflation changes have gone from close to zero to well above 2%, yet gold prices have not changed and have been stuck around $1200/oz. Gold prices have been struck at that level even with Eurozone CPI also at 2 percent. ECB president Draghi has called Eurozone inflation "relatively vigorous", yet the current gold direction is lower. 

Core inflation is lower than CPI in the Eurozone and the US, but the direction has still been higher. The Fed has continued to tighten and comments from the ECB is more hawkish although a reversal of their QE will be a long process. Nevertheless, there is still trillions of dollars in European bonds at negative rates and any reversal of policy will only make fixed income more risky. 

Calling the price level for gold is notoriously difficult but with risks in traditional assets and higher inflation in most developed countries, the current gold levels seem decidedly low. Even if there is the belief that inflation will be contained, there may be a safety argument for holding gold relative to fixed income. Still, the current gold prices suggest that inflation will be contained, economic growth may slow, and fixed income may be a good place to hold wealth.

A simple thought experiment is to compare the economic environment from 2-3 years ago with the current environment and ask a simple question; would you expect prices higher today than this date three years ago? If the thought experiment suggests gold should be higher and it is not, then the answer is that something is missing. There can be key facts missing, the scenarios are wrong or there is just complacency that is weighing down fundamentals. A current review says that something is missing in gold market expectations.  

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