ANALYSIS – Gold caught between worries over inflation and expectations of reduced economic stimulus

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By David Brough

Gold prices are caught between a rock and a hard place — buoyed by bullion’s appeal as protection against inflation but pressured lower by expectations that monetary authorities will soon reduce stimulus packages implemented to support economies during the pandemic.

Gold prices fell back in mid-October after surprisingly positive U.S. September retail sales data which boosted share prices and fed sentiment that interest rates would rise again from rock bottom levels sooner than previously thought.

At the time of going to press, bitcoin, as well as shares, had jumped, reducing the appeal of gold as an alternative asset class. Spot gold was down 1.5 percent to $1,768.38 per ounce on October 15.

However, gold prices were buoyed by nagging inflationary fears around the world, including in the UK, as supply chain shortages dragged on economic growth.

Gold was supported by an increase in consumer prices in the United States, the world’s biggest economy, although figures on October 14 showed U.S. producer prices posted their smallest gain in nine months in September.

U.S. consumer inflation rose solidly in September, driven by increases in prices of food, rent and other goods, according to data on October 13.

“The higher inflation is allowed to rise, the ever-greater will be the loss of buying power of the domestic currency,” wrote Lawrie Williams, gold price commentator with London bullion dealer Sharps Pixley.

“This will, in turn, lead to those looking to protect whatever wealth they may have, turning to tried and tested safe havens like gold.”

MAKAL

Credit: MAKAL

Jeff Christian of New York-based precious metals consultancy CPM Group said that while gold was a protection against what he called “catastrophic” inflation, it did not react in lockstep to gnawing inflationary trends, up one or two percent, and so on.

While gold is seen as an inflation hedge, reduced monetary stimulus, including expectations that U.S. interest rate rises may come earlier than previously expected, pushed government bond yields higher in mid-October, raising the opportunity cost of holding bullion, which bears no yield.

Some analysts believe that gold is undervalued because U.S. monetary authorities have been signalling inflationary pressures are transitory. Evidence of more prolonged ongoing price pressures may spur more gold buying. Some analysts are sceptical that inflation will be short-lived.

Currency impact

The pound hit a two-week peak in mid-October, underpinned by receding fears of a trade war between the EU and the UK, and on growing sentiment that the Bank of England could move to raise interest rates from their current historic lows earlier than previously thought, possibly as soon as this year.

Previously many analysts had predicted the UK central bank would not raise rates before late next year at the earliest.

A firmer pound makes purchases of dollar-denominated gold cheaper to UK-based gold jewellery manufacturers.

Currency markets are focusing on whether expectations of a possible UK rate hike later this year, are premature, with some analysts sensing that it may still be too soon to risk destabilising the economic recovery as pandemic restrictions ease.

If trade tensions between the UK and EU do pick up again, further gains by sterling against the dollar may be limited.

(Disclaimer:  Any views expressed in this article are solely views of the author and should not be seen as investment advice.)