Worries about future inflation prospects as a result of the 50 basis points cut in the federal funds rate Tuesday appear to be playing an increasingly greater role in gold's continuing rally, traders and analysts say.
The Federal Reserve's aggressive loosening of monetary policy has unleashed the specter of inflation in the gold market - whether real or imagined - and it's pitting traders' perception against a more cautious outlook by many economists. Worries about future inflation prospects as a result of the 50 basis points cut in the federal funds rate Tuesday appear to be playing an increasingly greater role in gold's continuing rally, traders and analysts say. Likewise, longer-dated Treasury products have been selling off on growing fears of inflation. Nevertheless, a situation appears to be emerging in which these markets are factoring in an expectation for price pressures that some economists do not necessarily share - with several economists saying they are not looking for a huge uptick in price pressures for the foreseeable future. During the strong rally in gold that began in August, analysts frequently cited the tumbling U.S. dollar as a catalyst, as the metal tends to move inversely to the greenback. The dollar has accelerated to the downside since the 50-basis-point rate cut in the U.S. federal-funds rate, with the dollar index on Thursday hitting a 15-year low of 78.45. Spot gold on Thursday hit a 27-year high of $738.65 an ounce, according to one price vendor, and the most-active December futures hit a 16-month peak of $746.50. But increasingly, analysts say much of the buying in gold has been on ideas that Fed easing could mean higher inflation going forward. "There's no doubt about it," said Patrick Fearon, precious-metals analyst with A.G. Edwards. "There is almost an inflation panic in some markets. It might be overdone. But nevertheless, there are some valid reasons to be concerned. The Fed is showing they are abandoning the inflation fight, and that's a bad thing." This comes as crude oil prices are hitting record highs, which could mean further inflation, Fearon pointed out, He said "protectionist sentiment" in Congress could boost inflation, since any legislation restricting low-priced imports can add to upward price pressures. Peter Schiff, president of Euro Pacific Capital, maintained that inflation has been an issue for a "long time" and has been much greater than reflected by the government's Consumer Price Index. This is due to the growth that has occurred in money supply, resulting in higher asset prices such as equities and real estate, he explained. Now, he looks for inflation to move into consumer prices and commodities, with inflation eventually perhaps getting even worse than in the 1970s. "As the dollar collapses - and it's going to fall sharply - prices are going to rise for everything," he said. Schiff also said the potential for increased inflation and a weaker dollar could mean "the most explosive move we've ever seen" in gold prices. "Gold is saying what Bernanke did is wrong," concluded Schiff. "The U.S. is in trouble. It's not a rosy (inflation) scenario." Leonard Kaplan, president of Prospector Asset Management, pointed out it's not just gold worried about inflation - the Treasury market is also selling off because participants "are now scared of inflationary expectations because the Fed has now thrown in the towel." The Fed's aggressive easing came even though core inflation (excluding food and energy) is already around 2%, thought to be the upper end of the Fed's comfort level, analysts emphasized. "The key is to watch the bonds," Kaplan said. "As long as they continue to fall, it shows inflationary expectations in gold will continue to go up." Investors continued to dump long-dated government bonds Thursday, with Treasury strategists saying the market also is growing concerned about the potential course of inflation. "The long end is just really, really unhappy with the 50-basis-points rate cut," said Scott Gewirtz, head of Treasury trading at Lehman Brothers. | |
| Economists' Inflation Views Are More Subdued | |
The bond and gold markets are reflecting ideas that "we have a proactive central bank trying to reflate," said Kathleen Stephansen, director of global economic research with Credit Suisse. But while Tuesday's cut and expectations for more easing may mean some inflation, she and others indicated they are not ready to start ramping up their forecasts. "The rate cut that was somewhat more aggressive than anticipated did affect inflation expectations, and that affects gold prices positively," she said. "That is clearly the dynamic going on today. Whether that comes to fruition is a different story." But by the end of 2008, she said, there may be enough pick-up in economic growth so that the Fed starts to take back some of its easing. Tim Rogers, chief economist with Briefing.com, remains optimistic that U.S. core inflation will remain contained in the next year. "I don't expect them (core data) to rise from where they are now - about 2%," he said. Dana Johnson, chief economist with Comerica Bank, expressed a similar view, but also said the sagging dollar is likely playing a major role in gold's gains. "I think inflation is pretty much a back-burner issue right now," he said. "The economy's sluggish growth over the last six or nine months has clearly resulted in a slowing of the underlying trend in inflation. "To me, the prospects of growth is going to continue to be sluggish a while longer. In that context, I would think core inflation is likely to continue to slow." Down the road, the economy may accelerate, resulting in higher inflation. But there will be time for the Fed to mitigate this, he said. "But to me, the current situation is one where inflation is likely to be dropping and it's very appropriate for the Fed to be offsetting the contractionary impact of the credit crunch." | |
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