Inflation driven upwards as well as the price of gold

While investor sentiment seemed more positive resulting in a general upward move of most equities and commodities, in the US, and after non-farm payrolls showed a larger than expected increase in March and rose by 216,000 while the unemployment rate dropped from 8.9% to 8.8%, hitting a two year low, the greenback failed to move upwards.

Although the greenback attempted a rebound in the middle of the week on the back of some hawkish comments from Fed officials, it later dropped after comments from New York Fed Dudley, who has a permanent voting seat on the Fed’s policy-setting panel, unlike other regional Fed officials who hold voting seats on a rotating basis. Dudley’s warned that Fed was “still very far away” from achieving its’ dual mandate of price stability and full employment and there is no reason to reverse course yet.

Lately the data that usually has a positive impact has had a negative impact and the data that usually has a negative impact, has had positive impact. There is something else at play here, and that missing link could well have something to do with the changes in monetary policy and the effects thereof.

The euro soared against other European majors as well as the yen last week, and at the same time, it remained firm against the dollar. Recent stronger than expected inflation data strongly suggests that the ECB is likely to raise rates in April and probably rate hikes in the future. The Eurozone CPI rose from 2.4% to 2.6% year-on-year in March, the highest level since October 2008 when CPI was at 3.2% year-on-year. This was also the fourth consecutive month that inflation has remained above the ECB’s 2% target.  It is widely expected the ECB will raise rates this week by 25bps from historical level of 1%. The upcoming ECB meeting this Thursday will be a closely watched event and President Trichet’s comments at the press conference after the announcement will surely move prices.

While the next FOMC meeting will not be held until April 24, speeches from Fed members will be closely watched. Recent comments from Fed presidents have turned more hawkish. Philly Fed President Charles Plosser said ‘signs that inflation expectations are beginning to rise or that growth rates are accelerating significantly would suggest that it is time to begin taking our foot off the accelerator and start heading for the exit ramp’. He also added ‘it’s certainly a possibility’ for the Fed to raise interest rates before the end of the year. The issue is ‘definitely on the table but it will depend on how things play out over the next few months’. In a separate statement, Dallas Fed President Richard W. Fisher said it ‘makes a lot more sense’ to stem stimulus measures as unemployment fell and the US’ growth is ‘self-sustaining’.

According to a report released by The Bank of Japan (BOJ) on Monday, the monetary base in Japan surged 16. 9 % in March from a year earlier, rising for the 31st consecutive month.
Huge amounts of extra liquidity were pumped into money markets following the massive March 11 magnitude-9.0 earthquake and ensuing tsunami that devastated homes, business and infrastructure in the northeast of Japan, as well as sparking an on-going nuclear crisis.

The BOJ pumped in the funds to ensure there was enough liquidity for banks and other institutions affected by the catastrophe to continue lending to each other.

The central bank maintaining very accommodating monetary policies as well as injecting emergency funds into markets has helped facilitate the increase in Japan’s monetary base in March.

With this expansionary monetary policy plus those of the US Fed and the ECB, inflation is set to increase, and the value of three of the most important currencies is set to decline. Add this to the rising prices of oil, and the logical conclusion is higher gold prices.

The price of oil jumped to a fresh 30-month high, on Monday and traded above $108 a barrel as fighting in Libya and unrest in the Middle East continued to raise doubts about future supplies.

Benchmark crude for May delivery reached $108.80 per barrel, the highest price since September 2008. In London, Brent crude increased by $1.35 to $119.70 a barrel on the ICE Futures exchange. While Libya’s oil exports have come to a halt, rebels are trying to ship some oil to help finance their uprising. Libya supplied about 2% of the world’s oil supplies, most of which went to Europe.

In Yemen, security forces opened fire on protesters in another violent anti-government skirmish. Yemen doesn’t produce much oil, but an extended conflict could disrupt nearby shipping lanes for tankers carrying nearly 4% of the world’s oil.

While gold prices will be very much influenced by changes in monetary policy, I also expect prices to remain firm and well supported by robust physical demand which will increase during price corrections. I also expect to see strong physical demand to continue from India and especially China. The People’s Bank of China (PBOC) recommended in the annual Financial Markets Report to buy gold as a hedge against inflation and as value preservation in a world where major currencies were declining in values against the precious metal.

In Hong Kong the demand for physical gold has been exceptionally strong with prices recording new record highs. Many experts and dealers in the bustling city remain very optimistic about gold mainly because of the Eurozone debt crisis and on-going political unrest in the Arab world.

In the medium to long-term, I believe the outlook for the yellow metal remains extremely bullish and the price will soon make new highs.

The price of gold has come up against resistance at around $1440. However, once it breaks this level the price could move rapidly to $1480. 

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.