Gold Asks: Where Is Inflation?
Sunshine Profits | Oct 15, 2020 02:23PM ET
The inflation remains low and below the Fed’s target. So, should gold bulls worry about it?
The CPI rose 0.2%, following a 0.4% increase in the preceding month.
On an annual basis, the overall CPI increased 1.4% (seasonally adjusted), following a 1.3% increase in August. The core CPI rose 1.7%, much like in the month prior (or a bit less if we abstract from rounding). Therefore, as the chart below shows, the period of inflation remains low. It seems that even though the inflation rate has reached the bottom in May or June, the outbreak of high inflation in the near future is unlikely.
Indeed, the expectations from the inflation rebounded after a plunge during the coronavirus crisis. But, they have stabilized around the pre-pandemic level, at which market players don’t see an outbreak of inflation, as shown in the chart below.
So, is Mr. Market right that the inflation will remain low, i.e., below the Fed’s target? Well, he might be. After all, the pandemic caused a profound economic shock, and the demand remains subdued. Now, with the new wave of COVID-19 infections and the slow economic recovery within the fourth quarter, inflation could remain tepid for quite some time.
However, it is also possible that both expectations and the inflation itself will be increased over the medium term. This is due to another boost in government spending monetized by the money supply (see the chart below) – there is always a lag here that can last from 6 to 18 months), and the declining confidence in both the government and the central bank.
At some point it should be clear for everyone that the interest rates until the inflation stays above 2 percent for a certain period of time. As long the Fed remains behind the curve, gold should shine.
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To put it differently, the lack of higher inflation is not surprising at all. After all, during recessions , the uncertainty increase and people decide to spend less of their incomes than previously. So, the demand for money increases, which neutralizes part of the rise in the money supply. However, when the crisis finally ends, people will gradually withdraw their cash balances. Therefore, we could still see a higher inflation. But it will not happen now. Instead, it will occur when the situation normalizes, and the economic recovery sets in for good.
And, who knows, maybe this is a crazy idea, but isn’t is possible that the Fed expects such a scenario, and it is the reason why it changed its monetary regime to allow for higher inflation? In any case, investors should remember that although higher inflation is an upside risk for the gold that would support its prices, gold does not need – as the 2000s and 2020 bull market showed – double-digit inflation to shine.
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