Make Kitco Your Homepage

Stagflationary concerns send gold to the key $1800 level

Commentaries & Views

In this column last week, I mentioned the importance of a sharp $30 intraday reversal which took place in the gold price on the last “book squaring” trading session of Q3. Technically, this sudden move back above $1750 held the gold price inside the bullish symmetrical consolidation triangle that has been forming over the past 14 months.

Since the beginning of Q4, the gold price has been biding its time until key inflation reports were issued this week, trading in a tight $30 range no matter what has happened. Each time the bears made a push towards $1750, buyers showed up quickly. And each time the bulls took gold towards resistance at $1780, sellers came in to knock the price back down.

But the gold action beginning this Wednesday was different, as both gold and silver broke higher out of a month-long consolidation surrounding the issuance of the U.S. Consumer Price Inflation (CPI) report an hour before the U.S. stock market opened.

The schizophrenic gold price action mid-week began when the headline CPI for September came in at 0.4% month-over-month, 0.1% higher than expected, and the core rate was up 0.2%, in line with the consensus. With computer algorithmic trades set to sell a slight uptick headline in annual CPI data, due to Fed taper concerns, the gold price sold off all of its $18 gain immediately.

However, after investors began reading over the data stating food prices, energy costs, utilities, and new vehicles have been rising four consecutive months and showing 5+% inflation, the Fed’s transitory argument became more suspect. The volatile Comex session ended with the gold price zooming towards the key $1800 level.

There is strong resistance at the $1800 level in gold, which also coincides with the metal's 200-day moving average. The volatile price action mid-week showed investor demand for bullion overwhelmed the short-term trader selling, which could be the sign of an important shift in the precious metals market. Both gold and silver have developed an inverted head and shoulder pattern on their respective daily charts. This bullish technical pattern could be targeting the descending trend line at the $1840 level in gold.

Meanwhile, worsening supply chain disruptions and a raging energy crisis have joined forces recently to reawaken fears of a stagflationary blow to the global economy. With energy bills skyrocketing, companies are seeing profit margins get squeezed and passing those costs down to consumers, at a time when supply bottlenecks are already restraining growth as central banks are moving towards higher rates.

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 talking 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 $110 in 1976 to $850 per ounce by January of 1980.

With the current Fed view being that inflationary pressures are likely “temporary,” 1970’s Fed Chair Arthur Burns insisted that the spike in inflation was transitory as well, even as prices shot up at double-digit percentages month after month. This notion that inflation will just fade is something that has very painful memories for economist Stephen Roach back in the 70’s.

In a Quartz interview this week, Roach, who worked closely with Arthur Burns in the 1970’s, stated “(Burns) forced us to create price indexes that took out the special one-time recurring glitches….we actually created something that didn’t exist back then, the first core CPI, where we stripped food and energy out of the CPI. We kept, in Burns’ insistence, taking more things out because more price pressures started showing up in things like used cars and home ownership and women’s jewelry and mobile homes. All sorts of things.” Roach continued, “We took so much out, we didn’t have much left and that was still rising, and only then did the Fed and Burns concede that we had an inflation problem.”

Earlier this week, the International Monetary Fund (IMF) trimmed its global growth forecast, citing rising risks from supply chain bottlenecks, price pressures, and threats from the delta variant. In its World Economic Outlook, the IMF said its 2021 global growth forecast is now at 5.9% from the previous July estimate of 6%.

For now, however, inflation risks are "skewed to the upside," while growth risks are "tilted to the downside," the report pointed out. "Inflation risks are skewed to the upside and could materialize if pandemic-induced supply-demand mismatches continue longer than expected." The IMF is warning the Federal Reserve to prepare to tighten its policy. These statements by the IMF echo what took place in the 1970’s, which describes an environment of higher inflation and lower growth, known as stagflation when gold thrives.

The Federal Reserve signaled on Wednesday it could start reducing its crisis-era support for the U.S. economy by the middle of next month, with a growing number of its policymakers worried that high inflation could persist longer than previously thought. Though no decision on a "taper" of the U.S. central bank's $120 billion in monthly asset purchases was reached at its Sept. 21-22 policy meeting, "participants generally assessed that, provided that the economic recovery remained broadly on track, a gradual tapering process that concluded around the middle of next year would likely be appropriate," according to the minutes of that meeting.

After the release of the September CPI this week, the more persistent inflation pressure figure pretty much guarantees the Fed will begin its tapering in November, and it could be more aggressive than what Fed Chair Jerome Powell had described a month ago. Investors are looking for signs from the Fed that the central bank is finally going to admit that inflation is more persistent than transitory, which will continue to drive rate hike expectations. The CME FedWatch Tool already shows that markets are pricing in a 40% chance of a rate hike by June 2022.

The last rate-hike cycle began in December of 2015, which is also when gold made a significant low at $1054. This bottom also marked the beginning of Phase 2 of the secular bull market in gold that began at the turn of the century. Heading into this significant bottom in bullion, gold stocks had already begun to create a flat bottom six months prior to the gold low.

In this column last week, I also mentioned the miners beginning to show relative strength to the gold price since the last trading session of Q3. This is evidence of smart money becoming fixated on the stagflationary pressures now more evident in the marketplace.

After rising for the past 10 of 11 sessions from deeply oversold levels, the GDXJ became short-term overbought on Thursday when the Relative Strength Index (RSI) reached the 70 level on a daily basis. With the mining complex at historic lows in relation to over-priced equities, this is a great time to begin scaling into quality precious metals juniors on weakness before the next up-leg is confirmed in this secular gold bull market. If you require assistance in doing so, and would like to receive my research, weekly newsletter, portfolio, watch list, and trade alerts, please click here for instant access.

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.