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Is the Recent Rise in Gold Predicting Coming Stagflation?

Commentaries & Views

The term "stagflation" was first used in the United Kingdom by politician Iain Macleod in the 1960’s, while he was speaking in the House of Commons. At the time, MacLeod was speaking about inflation on one side and stagnation on the other, calling it a "stagnation situation." It was later used again to describe the recessionary period during the 1970’s following the oil crisis, which fueled the gold price to soar from $35 in 1971 to $850 per ounce in January, 1980.

Rising taxes in the eurozone has increased the cost of doing business and is causing prices to rise. However, they have been rising only because of higher costs and not demand. Therefore, you have rising prices defined as inflation but without the economic growth or demand, creating a breeding ground for stagflation. This has been instigating rising civil unrest as the standard of living is declining with the net disposable income.

Moreover, the World Trade Organization (WTO) warned on Tuesday that its leading indicator of world trade in goods fell to its lowest level in nine years. Many economists believe the WTO’s latest indicator signal could be a precursor of a major slowdown in the global economy, with possibly negative repercussions for the U.S. economy. It also underscored the continued trade dispute between the U.S. and its chief trading partner, China.

I believe these factors have been the root cause of the gold price beginning to break out in most major currencies, while also ignoring recent firmness in the U.S. dollar. Gold has already made an all-time high in the commodity driven Australian dollar and is closing in on an all-time high in another commodity driven currency, the Canadian dollar. Whether its gold priced in CNY, EUR, JPY or AUD, it’s all the same chart - gold has had a strong rally in every currency and is going up in real terms, not because of U.S. dollar weakness.

This week's buying in materials came mainly from gold and copper stocks as both commodities are having a strong week. In fact, copper is breaking out of an eight-month base and closed Wednesday at its highest level since July of 2018.

The market may also be anticipating a trade deal with China as talks between the second largest economy and the U.S. are reported to be making progress with negotiations to continue during the coming week. The aim of the talks is to reach an agreement before March 2nd, when President Trump said he would raise tariffs on US$200 billion worth of Chinese goods to 25% from 10%.

Oil prices also look set to continue to increase after OPEC said that production from its members fell by nearly 800,000 barrels a day in January to 30.8 million bbl/day. This, combined with Saudi Arabia stating that it would cut output by at least 500,000 bbl/day more than originally planned to 9.8 million bbl/day, saw crude oil hit a three-month high yesterday. This suggests that investors are taking a second look at commodity assets due to possible rising inflation.

Moreover, as the gold complex continues its move higher along with a firm U.S. dollar and rising equities, the GDX surged to its highest level in nearly a year on Wednesday. After some lower volume profit taking yesterday, the global miner ETF appears headed for a test of long-term resistance at $25, which was the high formed during the first quarter of 2018. After consolidating between the start of 2017 through the summer of 2018, miners appear to be back in rally mode and have begun to lead the stock market.

The ratio of the GDX divided by the S&P 500 has also been trending higher once the stock market began to sell off in October of last year. This is the first time since early 2016 that gold miners have performed better than the stock market and is another positive sign of gold possibly completing a nearly six year basing pattern soon. An April Gold monthly close above $1362 next Thursday would confirm a technical bottom being in place for long suffering bulls.

However, minutes from the Fed's January meeting on Wednesday showed some members willing to stay "patient" on any rate hikes as long as inflation shows no signs of rebounding. This stance was expected, so gold began to sell off from strong resistance at $1350 after the minutes were released. The market could also be beginning to price in the possibility that any inflationary threat from higher commodity prices might be enough to cause some members of the Fed to have second thoughts about their newly-adopted dovish stance.

Nevertheless, the rising gold price in commodity based major currencies towards all-time highs could be signaling a coming period of stagflation where economic growth has been declining and the rise of commodities is signaling coming inflation. Annual growth rates have been in a bear market since the 1950’s and the bigger government becomes, the more it must extract from the economy to sustain itself. Central Bank gold buying is also up an astounding 74% year-over-year, which is the highest annual net purchases since Nixon closed the gold window in 1971.

The main economic theory of stagflation is that the confluence of stagnation and inflation are results of a poorly constructed economic policy. Many analysts feel the Fed is making a mistake by announcing a pause in its rate hike policy, which may eventually put them behind the inflation curve. If this is indeed the case, when combined with the already declining global economic growth, gold could be sniffing stagflation coming into the global economy.

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.