Watch For Tuesday’s Inflation Data For A Cue On The Fed And Gold Prices

My brother always said he would only start to buy gold when the Fed finally raised interest rates because that would be the signal that inflation was a threat to the US economy and a bullish indicator for future gold prices. That’s not what Goldman Sachs would have us believe, although the experience of the late 70s has always cast doubt on their theory about gold prices: back then both cash and precious metals delivered better returns than equities and bonds in a period of very high interest rates, except that gold and silver did outperform cash by a wide margin. 

On Tuesday this week the US Consumer Price Index will be released at 8.30am EST. Recent hints from members of the Federal Reserve Board are that it will show inflation ticking higher. The impact of lower energy prices on the data is now receding and the stronger dollar. Price rises elsewhere in the economy are being felt and the CPI data series only lags what others observe day-to-day by a relatively short period. 

Gold Prices

Could this be a cue for gold prices to advance this week after four down weeks? Certainly it strengthens the case for recent price weakness being a double bottom to the lows of early August. Higher CPI data will also increase the probability of a rate rise on December 16th, and be bad for stocks as well as bonds. Higher interest rates are a cost to business and will also jack up the US dollar, already trading at close to record valuation levels, and with 40 per cent of S&P 500 earnings coming from overseas that impact goes straight to the bottom line of America’s largest companies.

Besides what will crashing the stock and bond markets achieve for the Federal Reserve? It just creates another problem: the wealth effect or the lack of it after a crash. Many observers think the Fed will then just have to do what it always does to bail out a crashed market and print money with a QE4 program and maybe go for negative interest rates which are pretty popular with other global central banks at the moment.

But will gold prices take a dive along with stocks and bonds as they did in 2008-9? Well as alluded to in the opening paragraph of this article the historical precedent is far from certain for this correlation. Other factors may intervene, not least of which is indeed the future direction of an overvalued dollar if inflation is returning. Let’s also remember that in the late 1970s there was very high inflation - courtesy of the aftermath of the debts and money printing that followed the Vietnam War - combined with sub-par economic growth, but the dollar tanked. I can just about remember the pound sterling being at par to the dollar back then, and took a very enjoyable first trip across the Atlantic at modest cost.

US Dollar

The US dollar does look increasingly close to a recognizable top. You don’t buy what is expensive if you are an investor with an eye to the future. You buy what is undervalued, and what global currency is more undervalued at the moment than gold, apart from its sister monetary metal silver. And what would give us a final top in the US dollar?

Well, at the risk of going around in a circle with this argument, a rise in interest rates for the first time in nine years might just do the trick, especially if it was accompanied by a dash to cash in crashing stock and bond markets. Where would that cash go then? If history is any guide then precious metals are the ultimate safe haven when markets fall apart at the seams. George Soros has pointed that out in the past though he’s been so misquoted on this that he no longer says it anymore.

Global Financial Crisis

Just look at what happened as recently as 2009-2011 when gold prices tripled from their lows of the global financial crisis and silver was up seven-fold. Global investors do get this but they are fixated with the technical analysts who tell them a lower low is required in gold prices before the rebound can happen. Maybe the double bottom low discussed earlier in this piece is enough. Analysts like Avi Gilbert, who’s been right on price directions up to an including the 2011 reversal, seem to be coming around to this view and it’s the first time he’s been close to calling a bottom since then.

The danger of waiting to buy anything is that you just fail to do it. That could be a failure of nerve in a crisis, a relative being sick or just something you forget to do. Not everybody is a trader, and anyhow they also tend to be the most beaten up in a market disaster often having less than perfect judgement stoked up by leverage at just the wrong moment to be a market timer. 

Warren Buffett

Riding out market ups and downs as a buy-and-hold person can also require nerves of steel but at least you have a solid plan to stick to and do not have to switch around on a dime in difficult markets. Warren Buffett’s partner Charlie Munger says patience is always rewarded in investment if you have gotten the fundamentals right. Market timing is a nice extra if, and it is a big if, you can get it right too, of course.

Still back on planet earth something interesting is happening in the gold market with record US gold coin purchases and Chinese buying already past its previous record year of 2013. The retail buyers are back buying gold as a bargain. How long before the professional investors of Wall Street start buying the gold exchange traded products again? Perhaps like my brother the first whiff of inflation in the air will send them piling back into this undervalued asset class.

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Business & Travel Freelance Journalist
The Business Centre
Dubai Media City
Dubai, United Arab Emirates

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