Gold during Reflations

Jon Banking, Economy, Energy, Fiscal Policies, Gold, Market Commentary, Precious Metals

Reflation is coming. We argue that the recent comeback of inflation is negative for the gold market. Why should that be so? Should not inflation support gold, which is considered the inflation hedge? It is true that gold may shine during inflationary times, but a lot depends on the broader macroeconomic picture. Gold entered a bull market in the 1970s, but the U. S. economy was in a stagflation then, i.e. the combination of high inflation and sluggish economic growth. And inflation was high and accelerating. Will this scenario replay now?
The risk of stagflation, and the resulting possibility of a bond market collapse, is one of the largest risks for 2017 pointed out by investors. However, the current rise in inflation seems to reflect the uptick in economic activity and the jump in commodity prices. In other words, we see the return to normality after years of stubbornly low inflation rather than the start of high inflationary pressure. The deflationary forces are still in operation and the rise in oil prices should be limited by the increase in its supply, due to the fracking revolution. Therefore, the recent comeback of inflation should not support gold, as it results from higher economic growth and as it normalizes, not accelerates price dynamics. To put it simply, the increasing interest rates should keep inflation in check, so the yellow metal should not get an inflationary boost.
Other analysts point out that the central banks tighten monetary policy too much in a response to the inflation, which could hamper the economic growth or even lead to a recession. Well, it is possible, but central banks remain accommodative. Surely, they can overshoot, but it will take time to cause some turmoil and support gold (the same applies to the risk of inflation getting out of control – it will not happen suddenly). Therefore, the medium-term outlook for gold looks rather bearish, at least until the long-term upward trend in the U. S. dollar and real interest rates reverses.

This post was published at GoldSeek on Friday, 17 February 2017.