Monday, August 15, 2016

Gold, Crude, and other Inflation Gauges

Long-term gold prices appear to be in a consolidation range, with the $1,000 price acting as a support level, and by my approximation the $1,500 price acting as a potential resistance level. Industrial supply and demand for gold has always seemed in line with each other, while investment supply and demand, on the other hand, are subject to mismatching. This is usually the source of price shocks in the precious metal. The consolidation range that the price of gold is currently in, represents an equilibrium without any short-term inflation in general price levels. This means that investors are less likely to increase their inflation insurance. In cyclical terms, gold prices will consolidate around industrial fundamentals until investors have cause to increase their hedge against general price inflation.

The 10-year Treasury note price is exhibiting signs of strength, and a buildup of long momentum with both short-and long-term regressions trending higher. Strength in 10-year Treasury prices can signify investor belief that interest rates will not be increasing any time soon in any meaningful way. The S&P500, which has been the driver of financial asset price inflation, no longer has monetary policy as a tail-wind. The overall effect should be the S&P500 switching from a clearly defined upward trend, to a sideways trend. This is the type of environment where the ability to select stocks should yield higher returns compared to passive or index investing.

The dollar index appears to be finding long-term support above the 96.00 level. Overall strength in the dollar index provides little support to short-term price inflation, and consequently depresses commodity and import prices. Without increases in the price of goods and services, there is no justifiable reason for raising wages, and the resulting spillover.

Long-term oil prices are exhibiting signs of weakness, and a buildup of short momentum. The regression trends on one-year, five-year, and ten-year prices all have negative slopes. Longer-term trends in the crude oil market suggest that prices are consolidating around an equilibrium level that represents the matching of global supply and global demand for oil. When there is finally a mismatch of more demand than immediate supply of oil, we will see increases in headline and then eventually core inflation. Until then, we can expect more sideways movement in oil prices with a downward bias, and the same can be expected for general price levels.

When the time comes, and crude oil prices increase and push up the cost of everything that uses it as an input for creating a good or providing a service, investors will sell gold and government debt. As would be expected, any signs of inflation would be met with more monetary policy normalization through interest rate increases. Gold being an inflation hedge, will experience weakened investment demand, and government bond prices would respond to any monetary policy adjustments.

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