It was only a matter of time before gold prices broke through overhead resistance at the technically important $1,300 an ounce level. Now, $1,300 - plus or minus a few dollars - may be the new floor . . . and it looks like $1,350 may be the new ceiling.
At these price levels, the market’s supply/demand situation remains extremely “tight” with a growing shortage of readily available physical metal. This can be seen in the hefty price premium investors have willingly paid to take delivery of gold bars (in recent weeks as much as $40 an ounce in Shanghai, for example), the rise in gold loan rates, the modest backwardation in gold-futures markets, and reports of refinery delays in the delivery of gold bullion.
Dancing to the Fed’s Fiddle
In addition to the market’s internal supply/demand situation, gold prices have been ever more sensitive to U.S. monetary policy prospects - with every statement by Fed Chairman Ben Bernanke and other central bank officials parsed every which way by gold traders and speculators. In the past few months, expectations that the central bank might soon begin “tapering” its monthly asset purchases (akin to easing up on the monetary gas pedal) weighed heavily on the gold market.
But last week’s, comments by Federal Reserve Board Chairman Bernanke led many Fed watchers to now expect no change in the central bank’s program of quantitative easing until sometime next year - and this shift in expectations was quickly reflected in a firmer gold market.
Ironically, it was not U.S economic prospects and the outlook for Federal Reserve monetary policy but Japan’s Sunday election results (granting Prime Minister Abe’s ruling coalition in majority in both houses of parliament) that actually triggered the early Monday morning wave of buying in Asian markets that kicked gold prices smartly through the $1,300 an ounce level. The election results were interpreted as a popular mandate to continue Japan’s aggressive reflationary policies.
Gold still remains vulnerable . . . but, day-by-day, the chances of a significant decline below $1,300 are diminishing and the probability that we are in the initial stage of a major up-leg in the metal’s price is growing. For now, gold prices are still in a “bottoming phase” and may have more work to do around recent levels before moving substantially higher.
Although we can enumerate a number of proximate factors contributing to gold’s recent advance back over the $1,300 an ounce level, it is just possible that something more fundamental — but less visible — is at work. That something is a whiff of “stagflation.”
Stagflation, a period of low or negative economic growth coupled with high or accelerating price inflation may already be what ails us. Certainly, you’d think so judging from recently reported economic indicators.
Signs of Stagnation
Despite some favorable economic indicators here and there, the surest sign that the U.S. economy is stagnating is the persistent high rate of unemployment. The headline unemployment rate has been stuck around 7.6 percent while the broader U-6 unemployment rate, including discouraged workers who have dropped out of the labor force and part-timers seeking full-time employment, rose from 13.8 percent in May to 14.3 percent in June. Other labor market indicators, such as average workweek hours and take-home pay, also describe an economy that is stalling.
A modest improvement in consumer spending helped prop up the economy for much of the past year, but worried consumers are tightening their belts another notch. Retail sales grew by only 0.4 percent in June - however, after adjustment for inflation, retail sales in “real” terms actually fell a bit. Perhaps the increase in payroll taxes earlier this year is starting to bite. Similarly, sequestration - and the lost earnings of furloughed government workers and those employed by government contractors - maybe cutting into household budgets.
Exports have been another support for the U.S. economy during the past year - but faltering overseas economies (think Europe, China, India, Mexico, Brazil, etc.) will be buying less “Made in America” goods and services with implications for real GDP growth in the next few quarters.
Recent Inflation Indicators
The June Consumer Price Index was up by 0.5 percent, thanks to higher gasoline prices and higher costs for clothing, food, housing, and medical care. The Fed’s preferred inflation indicator, the “core” CPI, which excludes food and energy as if these items don’t count in every family’s budget, was up only 0.2 percent. So the Fed continues to have its eyes on the wrong target, fearing deflation more than inflation, despite the fact that many households are feeling the pain of higher prices.
Meanwhile, the Producer Price Index surged for the second straight month, rising by 0.8 percent. This is the fastest rate of increase since last September - and suggests more price pressures are in the consumer’s pipeline.
History as a Guide
The 1970s was a decade of stagflation here in the United States and just about everywhere else. The combination of inflationary pressures and sluggish business conditions was the result of financing the Vietnam War and the Great Society via the printing press beginning a few years earlier . . . and then in 1973 the Arab-Israeli “Yom Kippur War” followed by the OPEC oil embargo and the subsequent explosion in global energy prices.
Not surprisingly, it was also a decade of skyrocketing gold prices, with the yellow metal rising from $35 an ounce in 1970 to $850 an ounce in January 1980.
It sounds awfully familiar today, with America at war in Iraq and Afghanistan, along with high Federal spending on entitlements, financed largely by the Fed’s aggressive program of quantitative easing.
And, with instability across much of the Middle East (Egypt’s military coup, Syria’s civil war with no end in sight, and the possibility of military action spilling over into Lebanon, Israel gearing up for a possible attack on Iran’s nuclear facilities, Iraq and Afghanistan deteriorating into lawless states, Arab springs threatening to erupt in one or another of the Gulf states) a disruption of oil supplies to the world market is a real possibility.
Even without a Middle East oil crisis of one sort or another, recent U.S. consumer and producer price data may be early indicators of inflationary pressures in the economy. After all, inflation is a monetary phenomenon . . . and, for several years now, the degree of monetary stimulus by the Fed has been unprecedented.
