Global inflation remains elevated despite the latest rounds of strenuous efforts by major central banks to tame down rocketing inflation via the monetary policy route. Initially, the Federal Reserve pronounced the increase in Consumer Price Index as transitory and similar views were voiced by its contemporaries across the Atlantic, chiefly among them being the ECB led by the IMF veteran Christine Lagarde. These central banks share the same inflation target of 2%, whether by chance or by the need to appropriately synchronize their respective monetary policies, awarding due respect to their interconnected economies and financial systems. They have also voiced similar perceptions in regards to the position of gold in the post Brenton Woods monetary system. Fed Chairman J. Powell recently denigrated gold as nothing less than a mere instrument of speculation. Such comments are not comfy news for gold bugs who accept as true that gold is better than fiat currency.
U.S. inflation slowed down last month, bringing in some hopes that it might have already peaked at the decades high of 8.5%, therefore diminishing the need for the Fed to usher in more rate hikes at the next FOMC gathering. Inflation expectations remains elevated as supply chains disruptions remains elevated across the globe with geopolitical frictions playing a leading role in instigating the disruptions. Russia-Ukraine crisis coupled by the budding or rather persistent China-Taiwan friction has threatened to bring the global industrial output to a halt. Stagflation is knocking on the door and the Fed is busy firefighting the rising tide of a technical recession. The Fed has responded by hiking the FFR to 2.25% – 2.5% whilst the ECB responded with a hike of 0.5%, with the main refinancing rate is adjusted to 0.5%, the marginal lending facility to 0.75% and the deposit facility one adjusted from the negative region to 0.00%. For the ECB, it was the first interest rate hike since 2011, interest rates moving out of the negative territory bringing an end to Mario Draghi’s legacy of easy liquidity.
As global inflation ticks up, one would expect gold prices to respond positively as investors are believed to be inclined towards dumping fiat currency in favour of the yellow metal. However, this was the case before the financial markets developed some asset classes which are inflation protected, including the U.S. Treasury Inflation Protected Securities (TIPS). TIPS are essentially an alternative to investing in gold because they also bear the safe haven status based on the notion that they are backed by the U.S. government which is expected to meet up with its long-term debt obligations into the foreseeable future.
The real yields on TIPS have been improving as the Fed embarked on a series of rate hikes, therefore dismantling the desire for investors to embrace gold despite the soaring global inflation. The yellow metal is a non-yielding asset, therefore in modern times it is facing rising competition for the safe haven status from inflation protected assets.
Another point worth mentioning is the change of policy by the ECB, after a decade of negative interest rates the bank has decided to adjust interest rates into the positive territory. This has attracted the attention of bond holders who expect the ECB to maintain positive interest rates for the greater part of this decade, a move intended to reduce inflation whilst diminishing the excess liquidity that was generated during the Quantitative Easing program. The ECB has indicated that its €1.85tn Pandemic Emergency Purchase Programme (PEPP), launched in 2021, would be grounded to a halt in due course.
As the possibility of increase of real yields on both inflation protected securities and bonds announces its presence over the horizon, gold prices are inclined to be subjected to a mild to strong bearish headwinds as investors rotate their funds into yielding assets. The level of de-risking might actually escalate as witnessed by the continued sell-off of stocks on Wall Street. The leading health indicator of Wall Street, the S&P500 is currently down -14.71% from January 2022 peak at 4796.64, as sign of escalated market sell-off as the world’s largest flirts with stagflation. Gold is actually fairing even worse, standing at $1731.03 per ounce, a precipitous decline of -15.31% from the yearly peak. Precious metals are not having a good ride, the threat of a global technical recession fueled by several factors including persistent supply chains restrictions have clamped the demand for metals.
The demand for gold, palladium and platinum in the industrial world has declined significantly as the tech industry is failing to wade off persistent shortages of semi-conductors. Decline in industrial activity is contributing to the decline in the demand for the yellow, with the rise in bond yields afflicting the fatal blow. Eurozone industrial production recently recovered from a yearly low of -2.5% to stand at a meager 2.4% as compared to 8.4% during the same period last year. Chinese industrial production is struggling due to the reimposition of lockdowns, bringing down the industrial production to 3.4%, a 50% nose-dive as compared to the similar period in 2021.
Historical data, would have suggested that as inflation escalates, the prices of gold and its siblings were supposed to pulsate upwards. As stock prices plummet, investors were expected to dump stocks and inject their funds into bullion. The high inflation phenomenon, and rising gold prices that prevailed prior to Fed’s P.A. Volcker’s rate hikes back then. As inflation in the U.S. soared, gold prices sky rocketed to the then All-Time-High at $589.9 before the inception of Volcker’s tight monetary policy maneuvers. Therefore, the delay between high inflation and rate hikes awarded ample time space for gold prices to rise, as investors dumped cash and bonds in favour of the yellow metal. A tug of war now exists between inflation and real yields in determining in which direction the prices of gold will transcends towards. Given the Fed’s immediate response to escalating inflation, gold prices struggled upwards as real yields immediately ticked upwards in the aftermath of the rate hikes.
Tight monetary policy beyond certain limits (which are difficult to ascertain) will drag the U.S. economy into a technical recession as the Fed mops up excess liquidity in the economy. This approach might work against oiling the economy, given the fact that the U.S. economy is a consumer-based economy largely driven by debt. As liquidity dries up, Aggregate Demand is destined to become flaccid, triggering a chain reaction of reduced hiring, declining earnings and escalating unemployment. In such an environment, gold might regain its positive momentum once again, with the $2070 ATH as the primary target for the gold bugs.
