There’s no inflation … None at all. Only, completely by accident, lumber prices are skyrocketing. Gold is likely to remain silent, but it may catch up later.
What a surge! It happened because of the limited supply and strong demand for new houses. But it’s not just lumber. Many raw commodities are rallying too. The price of copper, for example, has just approached its record height (from February 2011), as the recovery of the global economy boosted demand. Just take a look at the price below.
Indeed, the trend is up. Commodity prices are on the rise as a whole as the chart below clearly shows. Even Warren Buffet warned investors against a “red hot” recovery, saying that his portfolio companies were “seeing very substantial inflation” amid shortages of raw materials.
Of course, commodity price inflation and consumer price inflation are quite different phenomena, as consumers don’t buy lumber or copper directly but only finished products made from these materials. However, at least part of this producer price inflation may translate into higher consumer prices, as producers’ ability to pass higher costs on consumers has recently increased – people have a large holding of cash and are willing to spend it.
Implications for gold
What do rallying commodity prices imply for the precious metals? Well, rising commodity prices signal higher inflation, which should increase the demand for gold as an inflation hedge. Of course, there might be some supply disruptions and bottlenecks in a few commodities. However, the widespread character and the extent of the increase in prices suggest that monetary policy is to blame here and that inflation won’t be just transitory as the Fed claims.
What’s more, the commodity boom is usually a good time for precious metals. As the chart below shows, there is a strong positive correlation between the broad commodity index and the precious metals index.
There was a big divergence during the pandemic when commodities plunged, while gold at the same time shined brightly as a safe-haven asset. So, the current lackluster performance of the yellow metal is perfectly understandable during the economic recovery.
Indeed, the rebound in gold has been weak, and gold hasn’t even crossed $1,800 yet, although it was close this week, as the chart below shows.
There was a rally on Monday (May 3) amid a retreat in the US dollar, but we were back in the doldrums on Tuesday, amid Yellen’s remarks about higher bond yields. She said that interest rates could rise to prevent the economy from overheating:
It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy
However, Yellen clarified her statements later, explaining that she was not recommending or predicting that the Fed should hike interest rates. Additionally, several FOMC members made their speeches, presenting the dovish view on the Fed’s monetary policy. For example, Richard Clarida, Fed Vice Chair, said that the economy was still a long way from the Fed’s goals and that the US central bank wasn’t thinking about reducing its quantitative easing program.
Anyway, the price of gold has been trading sideways recently as it couldn’t break out of the $1,700-$1,800 price range. This inability can be frustrating, but the inflationary pressure could help the yellow metal to free itself from the shackles. The bull market in gold started in 2019, well ahead of the commodities. Now, there is a correction, but gold may join the party later. It’s important to remember that reflation has two phases: the growth phase when raw materials outperform gold and the inflation phase when gold catches up with the commodities. So, we may have to wait for a breakout a little longer, but once we get it, new investors may flow into the market, strengthening the upward move.