Inflation drives gold prices higher. If the general level of prices increases, the yellow metal rises. It’s that simple.
Look at the chart below. It plots the price of gold (golden line) and the Consumer Price Index (CPI) (black line), the official measure of inflation.
You will notice a disparity; until 2013 the CPI and gold were moving in line, then everything fell apart.
Why? Investors bought into the idea that there will be next to no inflation in the U.S. In fact, they thought deflation would prevail at the period when prices decline. As a result, they sold the yellow metal, and eventually panic struck. Sadly, the same sentiment exists.
Chart Courtesy of stockcharts.com
How is Inflation Actually Looking?
On June 18th, the Bureau of Labor Statistics reported that the CPI increased 0.4% in May from the previous month. (Source: Bureau of Labor Statistics, June 18, 2015.) Saying the very least, this reading on inflation wasn’t great for those who say the yellow metal is useless to keep in a portfolio.
Bringing some perspective; the 0.4% increase in the CPI was the biggest month-over-month increase since March of 2013.
If we extrapolate, and assume that 0.4% will be the monthly increase over the next year, we are looking at inflation of over 4.8%. This is much higher than the Federal Reserve target rate of two percent.
It’s not only the government inflation figures saying there’s high inflation. Bonds markets are suggesting something very similar. Please look at the chart below of yields on the U.S. 10-year notes.
Chart courtesy of Stockcharts.com
Understand this; inflation is bonds’ worst enemy. Yields of the bonds go high when there’s high inflation. With this in mind, since February, yields on bonds have been rising—up over 40%. This shouldn’t be taken very lightly.
Where is Inflation Headed?
I have said it before in these pages, and I’ll say it again; inflation is headed much higher in the U.S.
I question whether those who are preaching deflation in the U.S. economy have been paying attention to the economic data at all.
You have to realize; since the financial crisis, the U.S. has been flooded with money thanks to the Federal Reserve. Look at another chart below. It plots the money supply in the U.S. economy. You will notice that it continues to increase.
Chart Courtesy of Stockcharts.com
Money supply in the U.S. economy has increased from $8.12 trillion in the beginning of 2008 to over $13.28 today. This represents an increase of over 83% in a matter of seven years, or about 12% each year.
At the very core, this is a prime example of monetary inflation where too much money is being printed and circulated.
Eventually, monetary inflation turns up into price inflation. The concept behind this is simple; there are too many dollars chasing the same amount of goods. This phenomenon results in higher prices.
Gold Market; Severely Undervalued
Looking at the current inflation figures and where they are headed next, the yellow metal looks severely undervalued. Gold has acted as a great hedge against rising prices for a very long time. I expect it to do the same this time around.
Remember; the best time to look at investments is when no one is looking at them. The gold market is certainly in that state—it’s overlooked. There are currently opportunities present that look more attractive in the long-run than any other asset class.