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Precious metals gained on
Friday amid the G-20 weekend summit, geopolitical concerns, and inflationary
pressures. Gold traded at $1,390 per ounce while silver was at $32.65 per
ounce. So far, February has been an interesting month for gold. The development
in emerging markets, inflationary pressures in the United States and
lingering geopolitical worries have all contributed to its rally.
Gold prices held steady as the
People’s Bank of China did what it can do combat inflationary pressures
at home. The price of gold was almost unchanged after reports confirmed that
the PBOC raised its reserve ratios to 50 points which will become effective
on Feb. 24, 2011.
It should be noted that the gold prices
were firm despite the fact that policymakers in China implemented a series of
tactics, even interest rate hikes, to contain inflation and cool its
overheating economy. Food prices in China are of particular concern because
an average working class Chinese citizen allocates a high proportion of their
income to buy food.
Fed Keeps Its Cool amid Inflation
Concerns
While Chinese policymakers are ramping
up their fight against inflation, Fed Chairman Ben Bernanke doesn’t
seem to think that deviating from his current policy of quantitative easing
and zero interest rate would be a good move at this time. Aside from buoying
gold prices, it also helped maintain the price of almost all asset classes.
In the United States, precious metals
are doing well because the Fed is keeping its commitment to keep monetary
policies loose in spite of skyrocketing commodity prices. Silver performed
better than gold this month, appreciating by 13%. Meanwhile, gold price only
increased by 4% in February. At its current rate, silver is trading at its
peak level since 1980 when the Hunt Brothers tried to dominate the market,
pushing the price of silver to $50.
High inflation brings one of George
Washington’s statements to mind, "paper money has had the effect
in your state that it will ever have, to ruin commerce, oppress the honest,
and open the door to every species of fraud and injustice." Around a
century afterwards, the effects of inflation are distinctly apparent. Today,
a dollar is worth less than 2 cents in purchasing power than in 1913.
As the wholesale prices rose broadly in
January, the fear of inflation is once against stoked. According to the
Bureau of Labor Statistics, the producer price index of finished goods,
excluding energy and food, rose to 0.5% last month. This is significantly
higher than the 0.2% increase that economists had expected in October 2008.
The overall index for finished products (goods delivered to retail stores)
increased 0.8%.
Inflation in the West Will Be Subdued
Right now, concerns about inflation in
the West are mainly centered on rising energy and food crises due to the
demand from emerging markets. Poor harvests and limited agricultural output
are further contributing to price volatility. The Federal Reserve has focused
more on core inflation due to the volatility of energy and food prices. Paper
products, jewelry and pharmaceuticals saw some of the largest price increases
last month. Joel Naroff of Naroff Economic Advisors said that,
"What’s worrisome is the accelerating increase in non-energy and
non-food prices."
Although pharmaceuticals accounted for
an estimated 40% of wholesale prince increases, Paul Ashworth of Capital
Economics said that the trend is unlikely to result in a sustained rise in
inflation because drug prices can be volatile. Core finished product prices
are only up 1.6% from last year. Ashworth further added that retailers cannot
pass along these price increases to consumers at this point despite strong
retail sales the previous year.
However, Eugenio Aleman, a Wells Fargo
economist, said that consumers will see higher prices eventually. There are
already grocery, clothing, and sellers of other goods that intend to raise
prices to offset their costs. If this happens on a large enough scale, the
Fed may need to raise short-term rates sooner or sell some of the Treasury
bonds it has been hoarding to decrease long-term rates. If the Fed takes
either course of action, recovery may be dampened.
In its January 25-26 meeting, the Fed
reported that it projects inflation to be "subdued." It expects the
inflation to stay at 1.3-1.7% for 2011 and 1-2% through 2013. The economic
growth forecast also increased to 3.4-3.9% from 3-3.6% in November. Some of
the reasons cited include rising business investments, consumer spending, and
factory output.
Despite this growth, the Fed said that
unemployment will still be high at around 8.9%. Prevailing weakness in the
construction sector, cautious hiring by employers, and tight credit would
hinder higher economic growth. Some Fed policymakers said that the recovery
may prompt it to shelve its plans to buy $600 billion worth of Treasuries by
June. But other policymakers believe that the current outlook is not likely
to change "enough" to prompt this action.
Gold
and Silver Prices
 
In the short term, the correlation between the dollar and gold indicates that the strength
of the greenback is one of the primary drivers of increasing gold prices.
Take note of the medium-high 0.59 coefficient found on the 30-day column.
Silver is correlated with stocks as is indicated by the 0.61 coefficient.
However, the Fed’s
low-interest-rate policy is not a short-term phenomenon, it’s a
long-term one. As such, it has implications for the precious metals market in
the long run. In this case, let’s take a look at the long-term column
– the 1,500 trading day one. The correlation coefficients are negative
and below -0.5 for gold, silver and mining stocks which means that the weakening
dollar will likely to influence these markets in a positive way over the
following years.
Overall, the signal for precious metals
at this time is bullish.
In the stock market, large-cap gold
firms are raking in their earnings after a quarter that propelled gold prices
to high highs. The CFO of Barrick Gold (ABX),
Jamie Sokalsky, said "We’re not inclined to view gold price as
being anywhere near the top." Gold prices have recovered over half of
its $118.72 slide from the all-time high last December 7, 2010 at $1,432.50
to its multi-month low of $1,313.78 on January 27, 2011. The price of gold is
expected to experience its third weekly gain. It is poised to breach the
$1,400 per ounce level once again.
Disclosure: I have no positions in any
stocks mentioned, and no plans to initiate any positions within the next 72
hours.
Rosanne Lim
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