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If Inflation Is Muted, What’s Driving Gold Higher? at Trader’s Narrative





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Market strategists have drawn a line and taken sides: is gold in a bubble? Jim Rogers and Nouriel Roubini had a verbal smack down via respective media interviews with the former manager of the Quantum Fund being the believer he’s always been in the power of commodities while the prophet of doom and gloom used the “b” word to describe the precious metal.

Now another pair of strategists have taken sides - although not as personal as Rogers and Roubini. Dennis Gartman, believes not only that gold is in a bubble, but that it should be obvious to everyone. But that doesn’t mean he’s necessarily climbing off the trend:


Meanwhile, David Rosenberg featured this chart to argue not only is gold not in a bubble, it is actually “cheap”:

gold relative to SP500 index long term chart

Leaving aside the obvious arithmetic (instead of logarithmic) scale, comparing the S&P 500 index to the price of gold is a non sequitur. This is due to the incessant rise of the equity index, with that itself due to the survival bias built into the constituents that make up the S&P 500 index. And don’t forget a dash of inflation which pumps up stock prices and therefore, stock indexes. So a ratio of gold to equity prices will for the most part look like a ski hill - and be as meaningful.

I’m also puzzled why Rosenberg is so bullish on gold since he has been one of the prescient strategists who has beaten the deflation drum the loudest.

Market Measure of Forward Inflation
Other than the CPI figures from the US government sources, there is a market determined inflation measure. It is the implicit inflation as per the Treasury Inflation Protected Securities (TIPS). The TIPS data that I showed back in 2008 is no longer published by the Fed. Thankfully, Bloomberg disseminates a metric based on the nominal forward 5 years minus US inflation-linked bonds forward 5 years. So basically, this is the average inflation that the bond market expects from 2010 to 2015:

5 year forward inflation expectations Bloomberg USGG5Y5Y
Source: Bloomberg

In the final days of last year, inflation expectations were the lowest in a very long time, fallin to just 0.41%. Earlier this month they reached 2.89% but today’s forward inflation expectation was still a muted 2.68%. Clearly, the bond vigilantes are not signaling a runaway inflation debacle in the near term future for the US.

So can it be that gold is in an honest to goodness bubble?

Gold Sentiment
Here are two measures of sentiment for the precious metal. The recent survey of Bloomberg terminal users on their conviction for gold found a remarkable 94% to be bullish.

That is a new record high since the survey started in 2004. Unfortunately, Bloomberg’s survey hasn’t been very good as a contrarian indicator. But it has rarely been above 90%. The closest it has gotten to this level was at the start of the year in January 2009 when it reached 91% bullish. Back then, gold was $900/oz. While there is a short history, the sheer lopsidedness of the recent consensus makes it noteworthy.

Courtesy of Elliott Wave, we get another measure of gold sentiment:

The Daily Sentiment Index (trade-futures.com) has been at, or above 90 percent gold bulls since November 3, a string of 10 straight days. The only other comparable streak of optimism over the past 22 years of data is leading up to the December 2, 2004 gold high when the DSI was at, or above 90 percent for 20 consecutive days. At that time, prices made a high at $458.70, declined over 10 percent, and did not exceed the December 2004 high again for the next 10 months. But during this entire 20 day stretch, optimism never reached the single day extreme that today did, with fully 97 percent of traders optimistic on gold’s future prospects. This time, we expect a larger decline, one that lasts longer too.

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5 Responses to “If Inflation Is Muted, What’s Driving Gold Higher?”  

  1. 1 Benjamin Burack

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    “I’m also puzzled why Rosenberg is so bullish on gold since he has been one of the prescient strategists who has beaten the deflation drum the loudest.”

    Gold is not an inflation hedge. It has never been a good inflation hedge. Yes, its price will generally rise as the dollar loses value (as gold is priced in values), but there are far better investments to hedge for inflation.

    Gold is the ultimate safety currency. While it can be expected to due poorly in periods of normal, moderate inflation (typically accompanied by economic growth), it will do well in times of crisis and uncertainty, whether severely inflationary or deflationary. As Japan approaches the brink and confidence in the dollar continues to decline (whether or not its value actually declines), gold increasingly looks like the only true safe haven for distressed capital.

  2. 2 JMS

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    Gold is the ultimate safety currency.

  3. 3 Mark

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    I know that doing gold prices relative to the S&P 500 like Rosenberg has done is a popular illustration and interesting to see, but that is not a valuation gauge of gold. It is meaningless. Why not price gold in cows or corn?

    The intrinsic value of gold should be based on its use as an industrial metal. Any price that someone might pay above that is speculative. You either think that it is pretty, it helps you sleep at night, or you are speculating on something - collapse of the global financial system, etc.

    Gold is not a business; it does not generate income; it does not have an R&D department or a sales staff. We dig it up from one hole in the ground and bury it in another. It is a speculation. “Valuing” a speculation is a guess as to what others will do: buy or sell. Not the same as a valuation..

    PS…Really like your blog…started following it in the last month or so…well done.

  4. 4 JBR

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    What’s factual for benchmark purposes is that the inflation-adjusted high for gold is over $2,000/oz… So it’s indisputable that gold has attained much higher prices than current levels, in constant dollars.

    Gold (like anything traded) is only worth whatever others are willing to pay for it (high or low) - but if everybody wants it, with the low/limited supply, that price can be pretty high. I think there’s a long way to go before most people lose faith in their fiat currencies like some already have.

  5. 5 Enquirica

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    Ultimately, the question is not how high gold can go, its how low fiat currency can go. While the debate about whether gold is in a bubble or whether we are in a deflationary or inflation environment continues, the monetary authorities in the developed world have embarked on a well-publicized campaign of currency devaluation via low interest rates. Central banks can control interest rates or exchange rates – not both – and they are opting for record low interest rates with little concern for the debasing consequences. There should be no debate on this matter – central banks have a perfect track record in one area and that alarmingly is in currency devaluation. The US and Canadian currencies have suffered a greater than 95% loss in purchasing power since the inception of their respective central banks. Enquirica Research has published a report – “Guide to Inflation Hedging 101″ go to enquirica and signup for access.

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