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Inflation’s Outlook Firms—How’s Gold’s Looking?

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Rising oil prices

The pace of inflation in the United States unexpectedly strengthened in December 2017 when the core consumer price index (or CPI) rose by 1.8% year-over-year (or YoY), including a monthly advance of 0.3%. The monthly gain was higher than economists’ expectation of a rise of 0.2%, according to Bloomberg.

Inflation expectations (TIPS) have risen due to the ten-year break-even rate (a market measure of inflation expectations) rising to 2.1%—the highest level since September 2014. Part of this rise is being attributed to higher oil prices.

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Tightening labor market

According to a Federal Reserve Bank of New York survey, US inflation expectations rose in December as younger and middle-aged workers expected higher prices and earnings. The survey showed expectations of 2.8% inflation in the next year, which is higher than the 2.6% recorded in November 2017. The December reading was the highest seen since February 2017.

Moreover, US unemployment is at its lowest in 17 years, with wage growth improving. This development should put upward pressure on prices, supporting inflation.

Higher producer prices

In December 2017, US producer prices fell for the first time that year. A major reason for this decline was lower food prices. Producer price inflation (or PPI) fell 0.1% month-over-month in December, whereas it rose 0.4% in November and October. On an unadjusted basis, the final demand index rose 2.6% in 2017, which is a healthy increase compared with the 1.7% improvement seen in 2016. An increase in producer prices usually leads to a rise in wholesale prices and eventually inflation (TIP). These prices have usually remained supportive and should lead to an increase in inflation in the months ahead.

Inflation could be a double-edged sword for gold prices. On one hand, investors pile into gold as inflation rises, to hedge their portfolio. On the other hand, higher inflation could prompt the Fed to increase rates aggressively, which would be detrimental to gold prices. In such an event, key gold stocks (GDX)(GDXJ) such as Gold Fields (GFI), IAMGOLD (IAG), Kinross Gold (KGC), and New Gold (NGD) could experience a drop in their prices. Company-specific factors led to annual gains for IAG, GFI, and KGC in 2017, whereas NGD fell 6.0% in 2017.

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