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Category: Bullion Bulletin

Bullion Bulletin: Inflation – still red hot

Hopes that inflation is being brought under control were dashed last week on the news that in the US in August the consumer price index (CPI) on an an...

18 September 2022

Gary Mead

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Hopes that inflation is being brought under control were dashed last week on the news that in the US in August the consumer price index (CPI) on an annualized basis was still at its highest in almost 40 years. Prices from a year earlier climbed 8.3%, higher than consensus expectations. July’s figure was 8.5%. August’s small decline was largely because of a substantial drop in gasoline prices, which fell by nearly 11% in August.

In the UK, the CPI for August was 9.9% higher year-on-year, a negligible drop from July’s 10.1%. As in the US, the drop in the CPI was attributed to lower retail petrol and diesel prices.

Some important questions arise from these declines in headline inflation.

Has the inflation peak been reached and are we now on the downward slope? Are we closer to fully understanding why inflation has been (and still is) so hot? What happens to the gold price in the weeks and months ahead?

• It’s premature to think that the inflation peak has been reached. One Bloomberg report asserts that in the US “from the point of view of the Fed, this report could scarcely be worse, and that means it’s bad for everyone”. The decline in energy prices was expected and is being offset by a rise of inflation in services. The US since 2019 has become a net exporter of crude oil and petroleum products and with its rise in natural gas output and renewable electricity generation the US consumer is largely cushioned against the rocketing rise in energy prices as a result of the Russo-Ukrain war. In the UK, too, a pullback in retail oil products’ prices (meaning the annualized inflation rate in that category fell to 32.1% in August against 43.7% in July) was counterbalanced by continued price rises in food (13.4% higher versus July’s 12.8%) and services (up 5.9% in August versus 5.7% in July).

• As to the root cause of this inflationary burst one of the real villains is the massive expansion of cash in the system. In the US, for example bank deposits were $1 trillion in 1980 but grew to $3.5 trillion in January 2020; by August 2022, they were an astonishing $18 trillion – a 414% jump in around two years, thanks to the overly-generous Covid-19 support handouts by the federal government. Governments in the US, the UK and the European Union (EU) have been pumping money into our financial system for years, in what was called Quantitative Easing, itself a legacy of the Great Financial Crash of 2008. Trillions of Dollars, Euros, Pounds have been unevenly distributed and have contributed to today’s inflation – and the recent droughts, floods, wars, have only added to the inflationary woes.

• The gold price: the universal reference price for gold is the US Dollar; as the Dollar has recently strengthened versus a basket of other currencies the Dollar gold price has weakened. A strong Dollar means that gold is more expensive for investors to buy and thus the gold price tends to drop. This is partly linked to inflation – the only tool the US central bank (the Federal Reserve) has to tackle inflation is interest rates. The Fed is currently embarked on a round of pushing base interest rates higher, to try to curtail consumer spending, and thus bring into line supply and demand (inflation essentially being too much money chasing too few goods/services). But as interest rates go higher, the Dollar and US bonds (Treasuries) become more attractive to investors, and gold less so. After the August CPI data became known for example the yield on the 2-year Treasury bond jumped to 3.78%.

• Given that the US Federal Reserve and the Bank of England (BoE) are still far from achieving their target of an annual rate of inflation of 2%, economic orthodoxy dictates that they will continue to raise interest rates – which will continue to strengthen the US Dollar and hence keep Dollar-denominated gold prices under pressure.

• Investment bank analysts are regularly scaling back their forecasts for the Dollar gold price. Société Générale analysts are now forecasting the Dollar gold price dropping to $1,550/ounce by the third quarter of 2023, on the basis that the Fed will need to keep relatively high interest rates for much of next year. They add that by the end of next year, gold prices will rise to $1,650 and push back to $1,900 by the end of 2024. If the US fell into a deep recession in 2024 then that “may force central banks to loosen policy again, which would weigh on the dollar… Moreover, a decline in economic conditions would affect corporate earnings, and the stock market could witness further corrections over the next 12 months, boosting gold prices”.

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