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What happens when you mix runaway fiscal stimulus with an extremely loose central bank monetary policy and restricted economic output? The plain and simple answer is: inflation.
The classical definition of inflation, in laymen’s terms, is “too much money chasing too few goods and services.” It’s the result of an ever-accelerating money supply meeting up with a reduction in the output of economic goods (defined as “a product or service which can command a price when sold”).
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A startling graphic that underscores just how much money has been created since last year’s pandemic response can be seen here. The M1 money stock graph (courtesy of the St. Louis Fed) illustrates the vigorous extent to which money supply has expanded since last April.
What’s more, a growing number of signs point to inflation making its malevolent presence known in various parts of the U.S. economy. Consider the following graph which shows the 5-year breakeven inflation rate.
This indicator is based on a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities. It suggests what participants expect inflation to be in the next five years.
As you can see, this indicator is currently at its highest rate in 10 years and is up over 100% from a year ago. It’s an undeniable sign that the market expects more inflation down the road.
The latest release of the Consumer Price Index (CPI) statistics, moreover, revealed a 2.6% year-over-year increase in inflation (versus the weak price action of March 2020) and is widely expected to climb for an 11th consecutive month in April’s report.
What’s more, many economists expect the annual inflation rate could climb above 3.5% for the first time since 2011 (a forecast which I think will prove too conservative).
Granted that most of the recent inflation is coming from significantly higher energy prices, which is by far the most volatile component of the CPI index. But energy costs alone can’t account for the renewed upward trend in domestic price inflation. It’s being seen in other areas as well, including in retail food prices.
Perhaps nowhere is inflation’s sting being felt more intensely than in the red-hot U.S. housing market. Soaring homebuilding demand, coupled with diminished housing inventories, has priced out countless numbers of prospective homebuyers. But lumber prices, which hit a record high of $1,400 per thousand board feet last month—an eye-popping sevenfold gain from the year-ago low—are another example of how inflation is impacting this important segment of the economy.
According to the National Association of Home Builders, soaring lumber prices alone have added an extra $35,872 to the cost of a new single-family home. It should therefore come as no surprise that after new home sales hit a 14-year high in August 2020, the number of new homes sold fell bey 27% through February 2021.
Other signs harbingering inflation include the S&P GSCI Spot Index, which tracks price movements of 24 raw materials, is up 29% in the year to date. This in turn reflects the persistent weakness of the U.S. dollar index in which commodities are priced over the past year.
All the aforementioned signs are of significance for metal investors since inflation is generally supportive for all metals—base and precious—but particularly for gold prices. Indeed, the yellow metal has long been used as a store of value to protect investors from inflation’s ravages.
Last year gold futures gained almost 25%, its biggest yearly increase in a decade, thanks to last year’s Covid-related panic and fears relating to the global recession. But gold prices sagged starting last August as rising confidence in the economic growth outlook in China and greater Asia overcame previous fears of a massive, multi-year worldwide slowdown.
However, recent events (including renewed dollar weakness) have conspired to revive gold’s fortunes. The yellow metal has since risen some 10% from its March 2021 low of $1,680 and has established a series of higher highs and lows, which suggests that a new intermediate-term upward trend is likely underway. (The recent breakout above the pivotal $1,800 level also likely served as a catalyst for short covering, as the bears were forced out of unprofitable positions.)
Gold’s revival is more than just a response to the increasing threat of inflation, however. Gold is benefiting from the latest weakness in Treasury yields. Gold competes with Treasuries for safe-haven investors since Treasury bonds offer a yield and gold does not.
A major reason for gold’s weakness between last August and March was the persistent rise in the 10-year Treasury yield. But with bond yields recently showing weakness, gold now has attracted the attention of safety-oriented participants, as evinced by its rally over the last couple of months.
But by far the biggest factor underpinning gold’s turnaround, in my estimation, is the return of the metal’s number-one, all-time bull market catalyst: fear. More than even inflation itself, gold’s price is heavily influenced by worries over economic, financial market and geopolitical concerns among investors.
Last year’s pandemic gave gold prices a decisive fear-induced boost, but the subsequent stimulus packages and vaccine rollouts diminished that fear, prompting investors to unload the yellow metal.
Now that inflation is on the rise, U.S. taxes are set to increase and worries over a possible stock market bubble are on the forefront of investors’ minds, gold has caught a new series of fear catalysts. It’s my view that these fears will prove to be both pervasive and persistent, providing gold with a nice tailwind to further keep the turnaround story alive.